Dynasty Trust

A dynasty trust, also known as a perpetual or generation-skipping trust, is an estate-planning tool that provides income and support to children and future generations of your family. Instead of wealth passing directly to your children, the assets reside in the trust, which helps protect them from estate taxes, the consequences of divorce, creditors and uncontrolled spending, while remaining in the family for generations.

Dynasty trusts are designed to protect the inheritance you leave to your children from creditors, spouses, and future estate taxes. Your mother can update her estate plan to leave you an inheritance in a dynasty trust instead of giving it to you out right. There are several advantages to this.

First, since it’s in a trust, your inheritance isn’t really your property, even if you are the trustee. That means your inheritance will benefit from creditor protection. While we cannot guarantee that you would never lose your inheritance in a lawsuit, a properly drafted and managed dynasty trust should protect you if you ever get sued.

Second, since your inheritance is held in a completely separate trust, segregated from your other assets, it’s easier to protect its status as your separate property than if you held everything directly in your name. Since you don’t really own your dynasty trust, neither will your spouse, even if you get divorced.

Third, and perhaps most importantly, a dynasty trust creates a dynasty.

The amount of your inheritance that is exempt from Generation Skipping Transfer Tax may be held within the dynasty trust for generation after generation with no additional estate tax due on your death, or the deaths of your descendants. The duration of the dynasty trust is limited only by a law called the Uniform Statute Rule Against Perpetuities, which requires a final outright distribution of the trust within 90 years of death.  And it’s even possible to create a dynasty trust in certain states (not California) that can last forever from a legal perspective. The point here is that if you invest your inheritance instead of spend it, then it can continue to grow for generations while continuing to avoid the federal estate tax.

If your mother creates a dynasty trust for their inheritance, she will be able to decide what, if any, rights you have to decide who gets to inherit the trust upon your death. Maybe she’ll let you cut your wife in for a share.  Or maybe not. She could even create a dynasty trust for your benefit with someone else as trustee if you’re not so good with money. With a dynasty trust, your mother can provide for her descendants for generations to come.

If you have significant wealth, and you wish to transfer that wealth to your children and grandchildren without having it erode due to estate taxes and unforeseen circumstances, consider a dynasty trust.

The GST tax is a flat tax, in addition to estate taxes, imposed on assets transferred to a beneficiary two or more generations removed from the person making the transfer (e.g., grandparents transferring assets to grandchildren). The combined taxes can approach 70% under current laws. However, a key exception to the GST tax is an exemption, which is $5, 340,000 million in 2014.  The unique feature of dynasty trusts is that they are designed to maximize your GST tax exemption.   Build assets for future generations

The assets in a dynasty trust are not subject to estate tax so long as the assets remain in the trust.  You can avoid gift tax on transfers into a dynasty trust, depending on the terms of the trust, size of the transfer and other taxable gifts you have made. With proper planning, a dynasty trust may be eligible to receive annual exclusion gifts from you of $14,000 ($28,000 per couple), multiplied by the number of beneficiaries.

The appreciation of assets in a dynasty trust will not be subject to additional estate or gift taxes. Some states have a rule against perpetuities, which limits the life of a trust to no more than 21 years after the death of the last beneficiary alive at the time the trust was created. The maximum length of a dynasty trust varies by state.

If the GST tax exemption ($5,340,000 million in 2014) is properly allocated to contributions, trust assets will not be subject to the GST tax.

A dynasty trust should ideally be funded with certain types of assets. Because federal income taxes may be as high as 39.6%, consideration should be given to assets placed with tax-free potential growth. Non-dividend paying growth stocks, tax-free municipal bonds and life insurance are appropriate choices to fund a dynasty trust.

You can make a tax-exempt annual gift of up to $14,000 ($28,000 per couple) on behalf of each trust beneficiary.  The gifted assets can then be used to pay for a life insurance policy that would provide a death benefit upon your death or the death of your spouse.  You can make a tax-exempt lifetime gift of up to $5,340,000 million (or $10,680,000 million per couple). Because the appreciation from the assets after they are gifted is not subject to transfer tax, your children and grandchildren can benefit without paying transfer taxes on the appreciation.

Using life insurance to fund a dynasty trust can help assure that your children and grandchildren will receive the full value of the trust through a death benefit. A life insurance policy purchased by a properly structured trust can provide a death benefit that is unaffected by estate and other transfer taxes and creditors (in some states).   With life insurance funding your dynasty trust, you can provide for your children or grandchildren and designate the remainder of your assets or savings for your own personal goals, such as charitable giving. Many grantors choose to use a dynasty trust as an irrevocable life insurance trust (ILIT), funding it with insurance on the life of the grantor. An ILIT is an irrevocable trust that may hold a life insurance policy outside the taxable estate, with provisions for maintaining and facilitating the ownership of the policy.

A dynasty trust is a type of Irrevocable Life Insurance Trust (ILIT). An ILIT is an irrevocable trust that owns life insurance. Annual contributions by the person who sets up the trust (the “grantor”) are used to fund a life insurance policy. Since it is irrevocable, an ILIT cannot be changed in any way once it is created.

The reason for creating an ILIT is that, if it is designed properly, trust assets are not included in the taxable estate of the grantor, and the death benefit is generally not subject to income or estate taxes. Note that there are exceptions, so be certain to consult your tax advisor.

The difference between a dynasty trust and any other ILIT is that the dynasty trust uses each grantor’s generation-skipping transfer tax (GSTT) exemption as a way to continue the trust for generations, while remaining outside of the beneficiaries’ taxable estate. In some states the trust can be set up to continue in perpetuity, which means it can virtually last forever.

The generation-skipping transfer tax (GSTT) is a flat tax imposed on all transfers that skip a generation. A transfer of assets from a grandparent to a grandchild may be subject to the tax, but a transfer from a parent to a child will not.

Purchasing life insurance in a trust leverages the exemption, since the exemption will be based on the premiums, not on the death benefit or the cash value of the insurance. Total premiums cannot exceed the grantors’ available GSTT exemptions.

The dynasty trust is set up so that one or more grantors can allocate their GSTT exemption to gifts made to the trust. This requires the grantors to note the gifts on a federal gift tax return.

The trustee, who is in charge of distributing assets from the trust, uses the gifted funds to purchase life insurance. The insurance policy may be a single life policy on the life of a sole grantor or a survivorship policy on the lives of a husband and wife as joint grantors. Joint grantors can use separate exemptions, which this year would total $3,000,000.

As long as the GSTT exemption covers all of the lifetime gifts made to the trust, all trust assets, including the death benefit from the life insurance, will be exempt from generation-skipping transfer taxes. If the ILIT is properly drafted and administered, the death benefit proceeds should also be free from income and estate taxes.

Trust asserts may be held for multiple generations, which restricts direct access for future generations.  The dynasty trust may be the only way to reduce taxes not only for yourself and your children, but for future generations.  Dynasty trusts are often created to remove the life insurance death proceeds from your taxable estate. However, unlike traditional ILITs, dynasty trusts are designed to remain in place for decades and provide for later generations through distributions of trust income or principal.  In today’s tax system, estate and gift taxes are levied every time assets change hands from one generation to the next.  Dynasty trusts avoid those taxes by creating successive estates that generally can outlive most of your immediate family members while continuing to provide for future generations.

This information is not intended to be tax or legal advice, and it may not be relied 
on for the purpose of avoiding any federal tax penalties. You are encouraged to seek 
tax or legal advice from an attorney or independent professional advisor.