What Are Dynasty Trusts?
Dynasty trusts are irrevocable long-term trusts that are designed to pass on wealth and assets across many generations. Like other trusts, dynasty trusts provide regular income to beneficiaries. However, their design ensures that such trusts are not taxed at estate tax rates.
The main advantage of dynasty trusts is their longevity. These trusts are designed to last for multiple generations and ensure that grantors and beneficiaries avoid double taxation. The disadvantages of dynasty trusts are that they can be expensive to create and maintain and they cannot be changed.
Basics of Dynasty Trusts
Typical trusts are limited in their duration and generally do not last more than a generation. Dynasty trusts are designed to work around these limitations by ensuring that their provisions outlast the grantor and initial set of beneficiaries. In effect, they provide steady income to multiple generations of the grantor.
Dynasty trusts also help avoid double taxation of the same estate. Grantors are on the hook for estate taxes after their death, if their estate is above the federal limit for that year. (The 2021 federal limit for estate taxes is $11.7 million). When the same estate is passed on from the beneficiary to their progeny, it is taxed again with the prevailing estate taxes for that year.
Even trusts that are designed to skip a generation are liable for transfer taxes. For example, all transfers above the exemption amount for the Generation Skipping Transfer Tax (GSTT) are taxed at the top rate of 40% in 2021.
In a dynasty trust, the assets from an estate are owned by the trust. Since the trust does not terminate with the immediate beneficiary, the assets are never passed onto them. The beneficiaries may derive income from it and pay regular income taxes on it, however. But they are exempt from estate taxes, when the trust’s contents are passed onto their next of kin. Thus, the trust is taxed only once (upon the grantor’s death).
Types of Trusts
There are two types of dynasty trusts. They are as follows:
- Grantor trusts: In this type of trust, grantors are responsible for taxes arising from the trust.
- Non-grantor trusts: In this type of trust, the dynasty trust itself is responsible for taxes arising from its operations.
How to Create a Dynasty Trust
The initial steps to create a dynasty trust are similar to the ones for creating any trust. You identify the assets to be included in the trust. Then ensure that you have the original ownership documentation for the assets to include them in the trust. Subsequently, you need to identify beneficiaries for the trust. That’s the easy part.
The most important part of creating a dynasty trust is its design. There are two things to remember about dynasty trusts. First, they are irrevocable trusts. This means that grantors cannot change them after creation. Second, they are perpetual trusts, meaning they are designed to last a very long time. It is in the grantor’s interest to make the provisions of a dynasty trust as flexible as possible to minimize administration problems for future generations.
Grantors can work around the irrevocable nature of dynasty trusts by using the special powers of appointment clause to allow future beneficiaries limited participation in management of the trust. For example, they may allow future beneficiaries to redirect their income or specify beneficiaries.
You can also reduce the dynasty trust’s income tax liabilities by choosing instruments that do not produce income, such as non-dividend stocks and bonds. You can also choose to create a dynasty trust on the state in which they are created. Many states are doing away with common law rules against perpetuities in trusts, making dynasty trusts more common. Often dynasty trusts may be created in states without income taxes to escape state taxation on distributions from the trust.
Because they are complex to create and maintain, dynasty trusts almost always require specialized legal help and can be expensive to create. Maintenance of dynasty trusts also incurs an annual charge that might prove to be substantial.
Advantages and Disadvantages of Dynasty Trusts
The advantages of dynasty trusts are as follows:
- They help avoid double taxation on estates, making them an attractive proposition in cases of large estates.
- They allow passage of wealth over a long period of time.
- Because they are structured as trusts, dynasty trusts help you avoid the probate process.
The disadvantages of dynasty trusts are as follows:
- The beneficiaries of a dynasty trust have limited control over assets and income from the trust.
- Dynasty trusts are irrevocable trusts and cannot be changed after creation.
- Dynasty trusts are expensive to create and maintain.
Dynasty Trusts FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.