Protect multiple generations with a dynasty trust

Adler Pollock & Sheehan P.C.

Adler Pollock & Sheehan P.C.

Dynasty trusts have nothing to do with the popular soap opera from the 1980s, but everything to do with leaving a lasting legacy. Although this type of trust is often created to reduce estate taxes, it can also provide other benefits and protections for affluent families. Most important: A dynasty trust may last for multiple generations.

A storied history

The roots of dynasty trusts can be traced to the common law principle known as the “rule against perpetuities.” This rule prohibited trusts from lasting indefinitely and was incorporated into laws in most states. Typically, state law would require a trust to end within 21 years of the death of the last potential beneficiary at the trust’s creation. Some states have adopted a simplified version limiting the trust duration to a certain number of years.

Tax benefits

In the past, dynasty trusts were used as a way to minimize transfer taxes between generations. For instance, if a family patriarch or matriarch leaves assets outright to adult children, the bequest is subject to federal estate tax in the transferor’s estate, and then again in the children’s estates when the assets pass from the children to the grandchildren, and so on. Although the federal estate tax exemption ($5.49 million in 2017) can shield assets from tax, the top tax rate on the excess is 40%.

What’s more, the generation-skipping transfer (GST) tax applies to most transfers made to grandchildren, thereby discouraging transfers that simply skip a generation. The exemption amount and top tax rate for the GST tax are the same as they are for the gift and estate tax.

With a dynasty trust, the assets are taxed just once, when they’re initially transferred to the trust. There’s no estate or GST tax due on any subsequent appreciation in value. This can save families millions of tax dollars over the trust’s duration. Of course, when a trustee eventually distributes the assets to beneficiaries, the beneficiaries may face income tax liability, depending on the step-up in basis rules.

The tax rules that apply to dynasty trusts could be affected by changes that are being debated in Congress this year. President Trump has advocated an outright repeal of the federal estate tax. However, the step-up in basis rules could be modified in conjunction with such a change.

Nontax benefits

Regardless of the tax implications, there are several nontax reasons to set up a dynasty trust. First, you can designate the beneficiaries of the trust assets spanning multiple generations. Typically, you might provide for the assets to follow a line of descendants, such as children, grandchildren, great-grandchildren, etc. You can also impose certain restrictions, such as limiting access to funds until a beneficiary earns a college degree.

Second, by placing assets in a properly structured trust, those assets can be protected from the reach of a beneficiary’s creditors, including claims based on divorce, a failed business or traffic accidents.

Look before you leap

Be aware that a currently effective dynasty trust is irrevocable. In other words, you may not be able to undo or even modify the arrangement if you have a sudden change of heart. Consult with your estate planning advisor to learn if a dynasty trust is right for you.

Sidebar: 3 Q&As on dynasty trusts

Q: How do you set up a dynasty trust?

A: A dynasty trust can be established during your lifetime, as an inter vivos trust or part of your will as a testamentary trust. An inter vivos transfer to a dynasty trust may have additional benefits associated with transferring assets with greater appreciation potential out of your taxable estate.

Q: Which assets should you transfer to the trust?

A: Because the emphasis is on protecting appreciated property, consider funding the trust with securities, real estate, life insurance policies and business interests. You should retain enough assets in your personal accounts to continue to enjoy your lifestyle.

Q: Who should act as trustee?

A: Your choices may include a succession of family members or estate planning professionals. For most people, however, a safer approach is to use a reputable trust company with a proven track record, as opposed to assigning this duty to family members who aren’t yet born.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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