A Dynasty Trust is any trust that lasts longer than one generation, but typically Dynasty Trusts are irrevocable trusts structured to last for multiple generations. In Florida, a properly structured Dynasty Trust can last for up to 360 years – that’s more than 15 generations. Assets transferred to your Dynasty Trust become sheltered from wealth transfer tax as long as the trust remains in existence. Another huge benefit is that trust assets are protected from your beneficiaries’ creditors. Here is a detailed discussion of these benefits, including other options to consider when structuring a Dynasty Trust for future generations:
Benefit 1: Dynasty Trusts Remove Assets from the Transfer Tax System
The primary benefit of a Dynasty Trust is that when you transfer assets to trust during your lifetime, the assets become sheltered from the application of future wealth transfer taxes. There are three types of federal wealth transfer tax: the estate tax, the gift tax, and the generation-skipping transfer tax (or “GST tax” for short).
In 2020, the federal estate and gift exemption is approximately $11.6 million per person. This exemption is unified, meaning that taxable gifts during your lifetime reduce the amount of assets you can pass at death estate tax-free. Taxable gifts mean the value of any uncompensated transfers you make in a given calendar year that exceed the gift tax annual exclusion amount, which in 2020 is $15,000.00 per recipient. This means that in 2020, you can give up to $15,000.00 to multiple individuals without paying a gift tax. Let’s look at an example:
Example 1: Mark is an unmarried individual residing in Florida with two adult daughters. In 2020, Mark gives each of his daughters checks in the amount of $15,000.00. Because the gifts do not exceed the gift tax annual exclusion amount of $15,000.00 per recipient, Mark does not have to report the transfers to the IRS, and his $11.6 million estate tax exemption remains intact.
Example 2: Same facts as above, except that in 2020, Mark gives his daughters checks in the amount of $20,000.00 each. Because the gifts exceed the gift tax annual exclusion, Mark must report the gifts to the IRS on a federal gift tax return (IRS Form 709), and Mark’s $11.6 million estate tax exemption will be reduced by $10,000.00 (the amount the gifts exceed the gift tax annual exclusion per recipient). Mark will not be required to pay a gift tax unless and until his $11.6 million exemption has been consumed by taxable gifts during his lifetime. In 2020, the estate and gift tax rate is 40 percent.
The imposition of the GST tax is in addition to the estate and gift tax. In 2020, the amount of the GST tax exemption is the same as the estate and gift tax exemption (approximately $11.6 million). The GST tax is triggered by transfers to a “skip person” (typically a grandchild or more remote descendant) that exceed the transferor’s available GST tax exemption. The GST tax rate also is 40 percent. For example:
Example 3: Mark dies in 2020 with an estate valued at $20 million, which exceeds his estate tax exemption of $11.6 million by approximately $8 million. Mark’s revocable trust devises his entire trust estate to separate spendthrift trusts for each of his four grandchildren ($5 million per grandchild). In addition to an estate tax liability of approximately $3,200,000.00, Mark’s grandchildren’s inheritance will be reduced by an additional $3,200,000.00 in GST tax. Thus, in this example, the grandchildren’s trusts will be funded with $13,600,000.00 of the original $20,000,000.00 trust value.
What could Mark have done differently to avoid more than $6 million of estate and GST taxes? Frankly, a lot of things. But for purposes of this article, we will focus on using Dynasty Trusts to reduce wealth transfer tax:
- First, Mark could have established and funded a Dynasty Trust for each of his grandchildren during his lifetime, instead of waiting until his demise when his net worth likely had peaked. Ideally, he would have done this before his net worth had accumulated beyond his available exemptions.
- Second, Mark would have started utilizing his gift tax annual exclusion to fund each of the Dynasty Trusts with at least $15,000.00 of assets per year to reduce the value of his estate in a tax-free manner.
- Third, Mark could have utilized his estate and gift tax exemption to make larger asset transfers to the Dynasty Trusts, thereby removing the value of the assets and any future appreciation from his overall estate, again without paying any wealth transfer tax.
- Lastly, Mark could have included a formula clause in his revocable trust to devise additional assets to the grandchildren’s Dynasty Trusts at death, but only to the extent of his remaining GST tax exemption, with the balance of the assets either passing to Dynasty Trusts for his daughters, or possibly to charity or a private foundation in order to generate an estate tax charitable deduction to offset the estate liability otherwise due to the IRS.
Once the assets are transferred to the Dynasty Trust, they become sheltered from the application of future wealth transfer taxes, meaning the assets will continue to appreciate for many generations to come free of estate and GST taxes. The Trustee of the Dynasty Trust is empowered to use the trust funds to pay for the health care, education, maintenance and support of the beneficiaries. The Trustee also can be authorized to use funds to pay for travel and residential and vacation properties, all for the use, enjoyment and happiness of the beneficiaries.
Benefit 2: Dynasty Trusts Provide Asset Protection for your Beneficiaries
To the extent a beneficiary of the Dynasty Trust would like to purchase a home or a vacation residence, the Trustee can use the trust funds to purchase these assets on behalf of the beneficiary. In other words, the Trustee, not the beneficiary, will own these investments for the use and enjoyment of the beneficiaries. The Dynasty Trust will contain a provision prohibiting the Trustee from distributing assets to or for the benefit of a beneficiary’s creditors. This type of provision is known as a “spendthrift clause.” Because the Trustee – and not the beneficiary – controls the trust investments, and because the Dynasty Trust contains a valid spendthrift clause, a beneficiary’s creditors cannot reach trust assets to satisfy a claim or judgment against the beneficiary.
Even responsible beneficiaries who are financially savvy could be involved in an automobile accident or divorce which otherwise would expose his or her inheritance but for the Dynasty Trust. Additionally, even the best physicians and attorneys are exposed to potential malpractice claims by virtue of their occupations. Therefore, a Dynasty Trust with a valid spendthrift clause is one of the strongest asset protection vehicles available to protect your beneficiaries’ inheritance from potential creditor exposure.
Benefit 3: Dynasty Trusts Are Flexible
Dynasty Trusts can be prepared in a way that allows them to adapt and react to future changes in the law and even the unique personality traits, talents and limitations of beneficiaries who do not exist yet but who will be born in the future. There also are several flexibility features to consider during your lifetime. For example, it is possible to structure the Dynasty Trust as a “grantor trust” for income tax purposes, so that even though you have transferred ownership of the assets for wealth transfer tax purposes, you still are considered the owner of the assets for income tax purposes. Why do this? Because it allows you to pay tax on any income generated by trust assets during your lifetime, thus allowing the assets to appreciate and compound much like a Roth IRA. The Dynasty Trust can be designed to turn off grantor trust status at such point you no longer wish to pay the income tax liability. If grantor trust status is turned off, then the trust becomes responsible for the income tax liability. Although irrevocable trusts can be subject to high income tax rates, this can be minimized by making distributions to trust beneficiaries who may be in much lower income tax brackets.
Grantor trust status also can be useful to maximize how assets are transferred to the Dynasty Trust. For example, instead of only using gifting, you also can “sell” assets to your Dynasty Trust during your lifetime by means of an installment sale. Because the transfer is a sale and not a gift, no gift tax will be due, and your estate tax exemption will not be reduced. Additionally, because you are considered both the owner of the assets being transferred (the seller) and the owner of the Dynasty Trust (the buyer) for income purposes, there is no capital gain due on the sale (essentially you are selling the assets to yourself). The only requirement is that the installment sale must include a minimal interest rate, which is documented by a promissory note between you and the Trustee of the Dynasty Trust. This technique allows you to transfer high-yield assets to the Dynasty Trust during your lifetime, thereby removing future appreciation from your estate, without having to pay wealth transfer tax or otherwise reduce your available exemptions.
Dynasty Trusts can be layered into your existing estate plan quite easily. If your estate includes stock in a family or closely-held business, using Dynasty Trusts, combined with tax-free annual gifting and low interest installment sales, can significantly reduce or even eliminate the wealth transfer tax your beneficiaries otherwise would have to pay upon your demise. The Dynasty Trust will shelter the trust assets from wealth transfer taxes for up to 360 years and provide your beneficiaries with significant asset protection for their lifetimes, thereby preserving your legacy for generations to come.
Choosing whether to have a Will vs. a Trust as the cornerstone of your estate plan, you should consider whether any of the factors noted above apply to you. While it is always appropriate for the estate planning attorney to make a recommendation, even a strong recommendation, one way or the other, the attorney’s main job is to provide you with the information required to make the best decision based on your unique estate planning goals and budget.