When people create estate plans, they typically focus on handing down their money and property to their children, grandchildren, and other living heirs. But some people want to leave behind a more enduring legacy. A dynasty trust could be the answer for those interested in multigenerational wealth transfer.
A dynasty trust is an irrevocable trust. It offers the tax minimization and asset protection benefits of other types of trusts. Still, unlike a trust that ends with outright distributions to your children or grandchildren, a dynasty trust can span more than two generations. Also known as a perpetual trust, a dynasty trust theoretically can last forever—or at least for as long as trust money and property remain. Because the trust could last for many years, and the rules generally cannot be changed once the Trustmaker creates the trust, the Trustmaker must set up a Dynasty Trust with great care.
A dynasty trust starts the same way as any other trust. The trust’s creator (i.e., the Trustmaker) transfers money and property into the trust, either during their lifetime or at the time of their death, in which case the trust is a testamentary dynasty trust. Regardless, as an irrevocable trust, once the Trustmaker funds the dynasty trust, the Trustmaker cannot revoke it. A trustee can only alter the rules the Trustmaker sets for the trust under specific state statutes governing trust modifications.
One role that the Trustmaker must seriously consider is who will act as the trustee. It is typical for the Trustmaker of a dynasty trust to name an independent trustee, such as a bank or trust company, to serve in this role because they can administer the trust for as long as it lasts.
While it is possible to choose a beneficiary of the trust to serve as the trustee, this raises potential tax and creditor protection issues. A beneficiary-controlled trust can have income and estate tax consequences depending on the terms of the trust and the scope of the beneficiary’s powers. Not only does a beneficiary’s ability to control the trust affect the degree of asset protection the trust provides the beneficiary, but it also risks family wealth to misappropriation. In addition, a corporate trustee, like the dynasty trust, has an indefinite legal life, allowing for uninterrupted administration across generations. Corporate trustees typically charge an annual fee based on the amount of money and property in the trust.
Estate planners like to remind people that trusts are for everyone, not just the wealthy. However, this general rule can be an exception for the dynasty trust. While you do not need to have the dynastic aspirations of the Medici family or the House of Windsor to set up a dynasty trust, most of the time, it is used by families with significant wealth.
No law says you need a certain amount of money to set up a dynasty trust. But practically speaking, a dynasty trust only makes sense if you have money and property that will last for two or more generations (although this depends on the monetary needs of your beneficiaries and how fiscally responsible they are). Trustmakers who think about multiple generations after their children set up dynasty trusts.
Another way to utilize a dynasty trust, other than handing down money to future generations, is to keep a family business in the family. Anyone who owns a family business is probably familiar with the dismal statistics about their longevity (e.g., 40 percent transition to a second generation, 13 percent make it to a third generation, and just 3 percent survive to the fourth generation or beyond[1]). Using a dynasty trust, the Trustmaker can place business shares in the trust to benefit multiple generations of beneficiaries. The trustee could be a professional trustee that can manage business affairs and maintain the continuity of operations while the beneficiaries benefit financially from the business. The Trustmaker can include terms that help ensure the business is run competently, such as requiring the trustee to have an advisory council that effectively serves as a board of directors.
Minimizing tax exposure goes a long way toward keeping your legacy in the family. You can use the federal estate tax exemption amount of $12.06 million per individual in 2022 (or twice that amount for couples) to fund a dynasty trust so that the money and property transferred directly to your grandchildren will not be subject to gift or generation-skipping transfer (GST) taxes. By placing accounts and property in a trust and timely filing a gift tax return to allocate appropriate tax exemptions to the trust or pay some wealth transfer tax, the IRS will not require your administrator to include those items in your taxable estate. This goes for your beneficiaries as well, as long as the trust is fully exempt from GST tax.
A trustee may use trust funds to pay a beneficiary’s living expenses or invest in a home for the beneficiary’s benefit without contributing toward the beneficiary’s taxable estate. You and your beneficiaries will not receive these benefits if you give them money outright. Even better, creditors and divorce courts cannot reach accounts and property you leave to your loved ones in a properly drafted dynasty trust.
The rule against perpetuities is a common law rule that limits the duration of controlled property interests, including trust interests. Although not explicitly written with trusts in mind, the rule against perpetuities effectively prevents people from using legal instruments such as deeds and trusts to control property ownership for many years after death. But the rule is notoriously difficult to decipher, leading many states to modify it to extend the applicable term or eliminate it altogether. Keep in mind, though, that you may be able to set up a trust in a state that you do not reside in with the help of an experienced estate planning attorney.
If you think a dynasty trust might be right for you, the next step is to speak with an estate planning attorney at our firm. We could discuss the trustee and beneficiary selections, tax and creditor protection considerations, state laws on perpetual trusts, and how a dynasty trust fits into your overall estate plan. To start planning your legacy today, don’t hesitate to contact us.
[1] Family Business Facts, SC Johnson Coll. of Bus., Cornell Univ. (last visited Sept. 20, 2022), https://www.johnson.cornell.edu/smith-family-business-initiative-at-cornell/resources/family-business-facts/.
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