Dynasty Trust: Definition, Purposes, How It Works, and Tax Rules

What Is a Dynasty Trust?

A dynasty trust is a long-term trust created to pass wealth from generation to generation without incurring transfer taxes—such as the gift tax, estate tax, or generation-skipping transfer tax (GSTT)—for as long as assets remain in the trust.  

The dynasty trust's defining characteristic is its duration. If properly designed, it can last for many generations.

How a Dynasty Trust Works

Historically, trusts could only last a certain number of years. Many states had a rule against "perpetuities" and stipulated when a trust had to end. A common rule was that a trust could continue for 21 years after the death of the last beneficiary alive when the trust was established.

Under those circumstances, a trust could theoretically last for 100 years or so. Some states, however, have done away with rules against perpetuities, making it possible for wealthy individuals to create dynasty trusts that can endure for many generations into the future.

A dynasty trust is a type of irrevocable trust. Grantors can set strict (or lax) rules for how the money will be managed and distributed to beneficiaries. But once the trust is funded, the grantor will not have any control over the assets or be permitted to amend the trust's terms. The same is true for the trust's future beneficiaries.

Dynasty Trust Beneficiaries

The immediate beneficiaries of a dynasty trust are usually the grantor's children (the person whose assets are used to create the trust). After the last child's death, the grantor's grandchildren or great-grandchildren generally become the beneficiaries.

The trust's operation is controlled by a trustee who the grantor appoints. The trustee is typically a bank or other financial institution.

Dynasty Trust Taxes

Assets that are transferred to a dynasty trust can be subject to gift, estate, and GSTT taxes only when the transfer is made and only if the assets exceed federal tax exemptions. However, income taxes still apply to a dynasty trust if assets produce income. Therefore, individuals often transfer assets to dynasty trusts that don't produce taxable income to minimize the income tax burden, such as non-dividend paying stocks and tax-free municipal bonds.

Additionally, the assets that go into a dynasty trust and any appreciation on those assets are permanently removed from the grantor's taxable estate, providing another layer of tax relief. 

A trustee can distribute money from the trust to support beneficiaries as outlined in the trust terms. But because beneficiaries lack control over the trust's assets, it will not count toward their taxable estates. Similarly, the trust's assets are protected from claims by a beneficiary's creditors because the assets belong to the trust, not the beneficiary.