With the Biden administration discussing changes to the tax code, it makes sense to consider creating a family legacy, like a dynasty trust, for your wealth now.
Estate planning opportunities today are very favorable, especially if you have assets you intend to gift in the future.
In 2022, the gift/estate tax lifetime exemption and the generation-skipping transfer tax lifetime exemption are both $12.06 million. However, if the tax law changes, you may forfeit millions in tax benefits.
What Is a Dynasty Trust?
A dynasty trust is a special type of irrevocable trust that can last for generations. Also known as a perpetual trust, a dynasty trust that can enable families preserve and transfer wealth from generation to generation without triggering transfer taxation such as gift, estate or generation-skipping transfer tax.
Determining if you should use a dynasty trust is a big decision, one that you need to consider thoroughly.
Here are some of the things you need to know before making your choice.
What’s the Difference between a Dynasty Trust and a Traditional Trust?
Time. With a dynasty trust, you can—in theory—pass down wealth for an unlimited amount of time. The length of time the trust can be in operation depends on state laws.
What Are the Main Benefits of a Dynasty Trust?
The main benefit of a dynasty trust is tax advantages. As a result of the 2017 Tax Cuts and Jobs Act, the federal estate tax exemption is $12.06 million. This means that you can place up to $12.06 million into a dynasty trust without facing estate taxes, gift taxes, or generation-skipping transfer tax. When a dynasty trust is set up properly, you can protect the wealth you created for your grandchildren and beyond.
Also, a dynasty trust enables you to protect assets for a long duration of time. Because the assets are owned by the trust, and not by the beneficiaries, the assets aren’t part of their taxable estates. This protects the trust’s assets from the uncertainty of future estate taxation, changing markets, family discord, creditors, and ex-spouses.
What Are the Disadvantages of Dynasty Trusts?
Now, let’s discuss the drawbacks to creating a dynasty trust.
Since dynasty trusts are irrevocable and perpetual, the terms you set up in the trust may become outdated. Once you’ve set the terms of the trust, you’re unable to make any changes. This means that dynasty trusts aren’t necessarily a good fit if changing family dynamics or asset structures could affect your future plans.
Also, setting up a dynasty trust is a complex legal process that requires significant time and money to accomplish. Since you’re setting up a dynasty trust in perpetuity, advisers need time to discuss who the trustees will be, what money and assets will be used, and under what circumstances the terms of the trust can be altered.
Lastly, dynasty trusts are sometimes set up so it seems like a hand is controlling from the grave. Since the trust is designed to continue and retain most assets for an indefinite period after its creators die, a dynasty trust often pays mainly income only to the beneficiaries. This income to your family can be eaten up by high legal and trustee fees, legal disputes, and misbehaving trustees.
As the grantor, you set the rules for the trust — no matter how strict or lax you might want those rules to be. Since the trust’s beneficiaries cannot change the terms either, so it is imperative that you set up your dynasty trust carefully.
Who Should Consider a Dynasty Trust?
A dynasty trust has the potential to serve as a great fit for anyone with great wealth that would like to pass on to their children, their children’s children, and so on. Dynasty trusts are designed for long-term generational wealth planning.
Also, ensure that you live in one of the states that allow dynasty trusts. A dynasty trust may not be an option if you live in one of the states that still enforce the Rule Against Perpetuities. This law originally limited the length of a trust. It was common practice for trusts to terminate 21 years after the passing of a trustor’s last beneficiary. Over time, many states have extended the time limitation or eliminated the rule completely. Dynasty trusts are allowed in Missouri and Illinois, as well as many other states.
To recap, a dynasty trust can be a good way to create a tax-efficient legacy.
Once assets are into dynasty trust, they are no longer subject to a 40% to 50% estate tax rate or the Generation Skipping Tax (GST), depending on what state you’re in.
If you decide to go this route, clearly outline your intentions and values in writing and regularly communicate with your trust beneficiaries. It’s important to talk about the family mission and legacy. This helps set expectations and creates peace among family members.
If you have questions, reach out to us at 314-961-1600 or contact us to discuss your situation.
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James Curran works with individuals and businesses and is passionate about getting to know his clients and their goals, both personal and professional. He spends time with them, helping to identify and solve their most pressing questions and concerns.
About Smith Patrick CPAs
Smith Patrick CPAs is a boutique, St. Louis-based, CPA firm dedicated to providing personal guidance on taxes, investment advice and financial service to forward-thinking businesses and financially active individuals. For over 30 years, our firm has focused on providing excellent service to business owners and high-net worth families across the country. Investment Advisory Services are offered through Wealth Management, LLC, a Registered Investment Advisor.