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 it's properly designed, it can last for many generations, possibly forever.
A dynasty trust that's established in the right state can theoretically last forever.
How a Dynasty Trust Works
Historically, trusts could only last for a certain number of years. Many states had a "rule against perpetuities" and stipulated when a trust had to come to an end. A common rule was that a trust could continue for 21 years after the death of the last beneficiary who was 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 their rules against perpetuities, making it possible for wealthy individuals to create dynasty trusts that can endure for many generations into the future.
The immediate beneficiaries of a dynasty trust are usually the children of the grantor (the person whose assets are used to create the trust). After the death of the last child, the grantor's grandchildren or great-grandchildren generally become the beneficiaries. The trust's operation is controlled by a trustee who is appointed by the grantor. The trustee is typically a bank or other financial institution.
- Dynasty trusts allow wealthy individuals to leave money to future generations, without incurring estate taxes.
- Under current law, an individual can put up to $11.4 million in a dynasty trust.
- Dynasty trusts are irrevocable and their terms can't be changed once they're funded.
A dynasty trust is a type of irrevocable trust. Grantors can set strict (or lax) rules for how the money is to 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.
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. As a result of the Tax Cuts and Jobs Act of 2017, the federal estate tax exemption is $11.58 million for 2020 and the amount will be adjusted annually for inflation. Of course, Congress could also raise or lower the estate tax exemption in future years, or do away with the estate tax entirely.
So, for now, an individual can put $11.4 million in a dynasty trust for his or her children or grandchildren (and, in effect, their children and grandchildren) without incurring these taxes. Moreover, the assets that go into a dynasty trust, as well as 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 to the beneficiary.
However, income tax will still apply to a dynasty trust. To minimize the income tax burden, individuals often transfer assets to dynasty trusts that don't produce taxable income, such as non-dividend paying stocks and tax-free municipal bonds.