Movie scenes where a deceased tycoon’s will is read to a roomful of shocked and bitter relatives make for great drama, but drama is the last thing anyone wants when seeking to preserve an estate for future generations.
An irrevocable trust ensures a far smoother transfer of assets than a will, while also offering significant tax advantages and greater privacy, control, and asset protection.
True to their name, dynasty trusts reign supreme among all trust types, providing the greatest benefits in all of these areas. Here are just a few of the reasons why creating dynasty trusts is a must for any family seeking to preserve an estate for multiple generations.
Minimizing Tax Liability
Whereas most trusts only provide for the transfer of assets from a benefactor to the next generation, or at most the next two or three generations, a dynasty trust can last for hundreds of years or more. This permanence offers tremendous tax advantages.
Under the Tax Cuts and Jobs Act (TCJA), as of 2019, an individual can gift or bequeath up to $11.4 million during his or her lifetime tax free. After that limit is reached, any further transfer of assets becomes subject to gift and estate taxes. The same transfer limit applies whether the benefactor leaves assets directly to heirs via a will or indirectly via a trust. However, in the case of a direct transfer or a short-lived trust, the same assets may be subject to the estate tax multiple times.
To demonstrate, imagine that Sarah leaves a $14.5 million estate to her sole heir, Michael, via a 20-year trust. When Sarah transfers her assets into the trust in 2019, $3.1 million ($14.5 million less the $11.4 million exclusion) is exposed to estate tax. If the highest estate tax rate of 40% applies to that $3.1 million, then $1.24 million of the estate will be lost at the initial transfer, leaving a value of $13.26 million. When the 20-year trust expires, the assets will become part of Michael’s taxable estate, so additional value will be lost when he passes the estate on to his children.
By contrast, when a grantor transfers assets into a dynasty trust, those assets become the property of the trust, not of the grantor or the grantor’s heirs. Because the trust endures for many generations, the estate tax is only assessed once, even if the trust later grows to be worth several times more than the lifetime exclusion.
When establishing a dynasty trust, remember three key words: location, location, location. Many states have “laws against perpetuities” that effectively ban dynasty trusts. However, five states allow perpetual trusts, while six others allow trusts with lifespans of 360 years or more. If your state of residence does not allow dynasty trusts, an experienced financial advisor can show you how to set one up in a state that does.
As an added tax bonus, because dynasty trusts are passed down successively from each generation to the next, trust assets are not subject to the generation-skipping transfer tax (GSTT). The GSTT is notorious for complicating bequeathals to grandchildren and others who are not immediate heirs.
Lasting Control to Protect Future Generations
When creating a dynasty trust, the grantor designates a trustee who will manage trust funds. Usually, the trustee is a reliable third party like a banker or wealth manager, rather than a trust beneficiary. The grantor can exert as much control as desired over the future of the trust by giving the trustee specific instructions for making trust distributions. For example, the trustee might only distribute trust funds to beneficiaries for major life events, or each heir might have a lifetime limit for distributions received.
By establishing such safeguards, a benefactor can ensure that the family’s wealth serves many future generations. However, consideration should be given to how far into the future the grantor’s control should extend. It is often wise to allow a loosening of the reins over time, since future tax rules and economic realities are impossible to predict.
Protection of Assets From Creditors and Exes
A common fear in the world of estate planning is that the family’s hard-earned assets will end up in the hands of a beneficiary’s ex-spouse or the creditors of descendants who live beyond their means. When established in a state with favorable asset protection laws for trusts, a dynasty trust eliminates this worry. Once again, because the assets are owned by the trust—not the beneficiaries—those assets cannot become part of an heir’s jointly held property, nor can they be pursued by debt collectors.
The state laws of Nevada, Ohio, and South Dakota provide particularly strong asset protection for dynasty trusts, with several other states getting high marks from legal experts, as well. South Dakota is unique among these states, however, in that it fully protects not only family assets, but also a family’s financial privacy.
Keeping the Family Estate Out of the Public Eye
Although those dramatic readings of wills for assembled heirs rarely happen in real life, the legal process known as probate does place a will into the public record. In other words, the will becomes a window through which the general public can gawk at any family’s financial secrets. Irrevocable trusts of all kinds provide far greater privacy throughout the estate transfer process, but in most states, this privacy protection has a vulnerability that few people know about.
If a trust becomes the subject of litigation—for example, if someone challenges the legality of the trust on grounds that the grantor was not of sound mind when it was established—trust documents will be entered into evidence. Unless the presiding judge agrees to place them under seal, the documents then become part of the public record of the case.
Some states give judges wide latitude to seal such documents, while other states make doing so very difficult. South Dakota uniquely protects the privacy of family trusts by locking down all trust records brought into court proceedings as standard procedure.
Quiet Trusts & Confidentiality Within the Family
It behooves all families to keep outsiders out of their financial business, but some grantors also have reasons to withhold information about trust assets from their heirs. Many worry that if their grandchildren grow up knowing that they will always enjoy a life of economic privilege, they will not embrace the challenges of learning, growing, and aspiring to realize their potential.
Some states have legal provisions allowing for the creation of “quiet” or “confidential” trusts. These trust structures allow trustees to conceal the value of a trust from beneficiaries for a specified period of time—for example, until the beneficiaries reach 25 years of age. In addition to South Dakota, states that offer protections for quiet trusts include Alaska, Nevada, and Delaware.
Now Is the Time to Explore Dynasty Trust Options
The current $11.4 million lifetime transfer tax exclusion will be adjusted for inflation through 2025. However, when the TCJA expires at the end of that year, the exclusion might revert to pre-TCJA levels ($5 million in 2010, adjusted annually for inflation) or be otherwise reduced. Since grantors can establish dynasty trusts at any time, including many years before their deaths, the current laws provide a great incentive to begin the process of creating a trust now, rather than leaving things to chance at some future date.
This article is not tax, legal, or other professional advice and cannot be relied upon for any purpose without consultation and advice from a retained professional.
As one of the most knowledgeable and well-connected tax & accounting professionals in the world, Harvey Bezozi's mission as a CPA and CFP ® is to provide concierge-level work product and service, along with seamless communication, high energy, and a super-positive attitude. Located in Boca Raton, Florida, Bezozi has been in business since 1994, and serves clients in all 50 states and internationally. More information can be found at YourFinancialWizard.com
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