A Dynasty Trust is a trust that lasts for a long period of time, often multiple generations. Briefly, a dynasty trust is a technique designed to allow its creator to pass wealth from generation to generation without the burden of transfer taxes, including estate and gift tax and the generation skipping transfer tax (GSTT). The technique passes wealth to successive generations of descendants with distributions and operation of the trust being controlled by the terms initially established by the grantor of the trust. The trust is irrevocable and, once funded, the grantor no longer has control of the assets and will not be able to reach the assets or amend the trust terms. Clients can achieve great economic benefits through the use of Dynasty Trusts. These benefits can include the accumulation of money inside the trust without the direct transfer of assets to any beneficiaries, excluding the assets from the clients’ taxable estate and potentially excluding the assets from the beneficiaries’ taxable estates.
Dynasty Trusts can also provide strong asset protection for future generations. Grantors have great flexibility with Dynasty Trusts in structuring long-term non-financial incentives to help beneficiaries learn more about handling and investing money before they have control of inherited assets, motivate beneficiaries to become involved with philanthropy, to encourage the beneficiaries to go to college or make a down payment on a home for a beneficiary.
How does a Dynasty Trust work?
To establish a Dynasty Trust, the client creates an irrevocable trust for the benefit of one or more beneficiaries such as children or grandchildren. The client can name the trustee(s). The trustee would be empowered to distribute income and/or principal for the beneficiaries’ reasonable support, medical care and/or best interests. This is a very broad standard. The beneficiaries can be given the power during their lifetimes and/or by will to appoint some or all of the trust’s assets to any one or more the client’s descendants. At the beneficiaries’ death, the remaining assets, if any, would be distributed to further, similar dynasty trusts, for his or her descendants.
Gift and Estate Tax Considerations
The gift tax system applies to transfers to Dynasty Trusts. Therefore, when considering the lifetime funding of a Dynasty Trust, consider limiting lifetime transfers to the amounts covered under the lifetime credit against gift tax and the annual exclusion amount ($14,000 per participant, per year in 2015). Any gift taxes paid on the transfer of assets to a Dynasty Trust are deducted from the client’s estate, reducing the estate (and thus the taxes paid) at the client’s death. Also consider the generation-skipping transfer tax (“GSTT ”) when creating a Dynasty Trust. The GSTT is a tax on lifetime and testamentary transfers to persons more than one generation below the transferor, at the highest marginal estate tax rate. If a client applies his or her lifetime GSTT exemption to transfer assets to a Dynasty Trust, the income and principal that accumulate inside the trust may be distributed free of the GSTT for the duration of the trust.
An important issue when setting up a Dynasty Trust is the applicable state’s rule against perpetuities (“RAP”), which generally provides that an interest in trust is invalid if it can last longer than the lives of persons named in the trust plus 21 years. Although this rule has been abolished or significantly modified in many states (limiting the duration of trust to several generations), clients wishing to create a dynasty trust that could last perpetually should consider creating it in a jurisdiction that has no RAP.