What is a Dynasty Trust?

Key Takeaways:

• Dynasty trusts allow wealthy families to engage in powerful tax and estate planning strategies by removing assets from the transfer tax system for multiple generations.
• Dynasty trusts – due to their perpetual nature – have the potential to benefit even remote future generations, providing not only tax savings but also potential asset protection benefits.
• Careful planning and coordination with professional advisors mitigates potentially unwanted challenges created by an irrevocable dynasty trust.

What is a Dynasty Trust and How Could it Benefit Your Family?

Dynast trusts, also known as perpetual trusts, are considered one of the most robust estate planning tools for ultra-high-net-worth families. These trusts have specific attributes that allow them to protect a family’s wealth from creditors and transfer taxes – and to do so for multiple generations and potentially forever. By removing wealth from the estates of not only the grantor, but also all subsequent generations, dynasty trusts offer the potential to permanently remove assets from the U.S. transfer tax system. However, this advantage does not come without significant potential challenges, which is why dynasty trusts are not a one-size-fits-all solution and are not appropriate for all families.

Dynasty trusts are made to last forever, so families must ask themselves and their trusted advisors if the advantages outweigh the unforeseen challenges – now and many, many years from now.

Overview of Transfer Taxes

One of the primary challenges wealthy families face when attempting to pass their wealth to successive generations is the U.S. transfer tax system, which consists of three different taxes: estate tax, gift tax, and generation-skipping transfer tax, often referred to as “GST.” Certain states also impose their own estate or inheritance taxes, but such state-level taxation is beyond the scope of this article, which will discuss only the federal transfer tax system.

The current federal estate and gift taxes impose a 40% tax on total assets above the applicable exemption amount that an individual either leaves as part of their estate or gifts to other individuals during life. The GST imposes an additional 40% tax on transfers to either a family member who is more than one generation younger than the grantor (such as a gift or bequest from grandparent to grandchild) or a non-family member who is more than 37.5 years younger than the grantor. All of these transfer taxes apply only after the relevant exemption amount has been exceeded.

The exemption for estate and gift taxes ($12.06 million per person in 2021) is a unified amount, meaning that gifts made during life that exceed the annual gift tax exclusion will decrease the size of the estate tax exemption available at death. The GST exemption was also $12.06 million per person in 2022. Prudent estate tax planning revolves around the efficient use of the exemption amounts discussed above, and trusts are often an integral part of such planning.

One of the primary challenges wealthy families face when attempting to pass their wealth to successive generations is the U.S. transfer tax system.

Planning With Trusts

One potent characteristic of a trust is its finality. When a grantor either gifts or sells assets to an irrevocable trust, the assets held within the trust are no longer considered part of the grantor’s estate for transfer tax purposes. This makes irrevocable trusts a powerful tool for planning.

Many estate planning strategies involve the strategic use of a grantor’s gift tax exemption to transfer valuable assets into an irrevocable trust so that such assets can grow outside of the grantor’s estate and subsequently not be included in the grantor’s estate for estate tax calculation purposes. Similarly, grantors can allocate their GST exemption to an irrevocable trust, thus allowing assets to be transferred to their grandchildren’s generation free of transfer tax, while also remaining outside of the grantor’s estate.

Traditionally, the main limitation on the use of trusts for very long-term planning was that trusts had a termination date, whereupon all the assets of the trust would need to be distributed to beneficiaries. The distribution to the beneficiaries then creates an estate tax issue for them if they later pass assets to their own descendants. Under common law, trusts were not permitted to last perpetually and were limited by the “rule against perpetuities.” This rule limited the potential duration of trusts to “21 years after the death of a life in being” at the time the trust was created. This restriction on trusts limited their practicality for truly long-term estate planning by forcing trusts to terminate in a limited time period – in practice, typically less than 100 years.

Many estate planning strategies involve the strategic use of a grantor’s gift tax exemption to transfer valuable assets into an irrevocable trust.

Some States Allow for Perpetual Trusts

While federal transfer taxes are, naturally, governed by federal law, the maximum duration of trusts is a matter of state law. As of 2022, several states permit trusts to exist perpetually, flowing to generation after successive generations of beneficiaries without any termination date. The obvious advantage of such a perpetual trust is that, by never terminating, it serves to remove assets from the estate of not only the grantor and the grantor’s children and grandchildren, but from the entire family line, possibly permanently. It is this element of such perpetual trusts that has given rise to the term “dynasty trust.” This strategy envisions a trust that allows a family and even its most remote descendants to enjoy the benefit of assets held in trust while permanently removing those assets from the U.S. transfer tax system.

As of 2022, several states permit trusts to exist perpetually, flowing to generation after successive generations of beneficiaries without any termination date.

Benefits of Dynasty Trusts

• Potentially permanent transfer tax planning: The most notable benefit of a dynasty, or perpetual trust is tax savings and the potential for “permanent estate planning.” By transferring assets to a trust that will never terminate, a family can remove those assets from the federal transfer tax system not only for themselves but for successive generations.
• Potential for powerful income tax planning: Additionally, a dynasty trust may be structured as a grantor trust for federal income tax purposes, which could allow the initial grantor of the trust to take responsibility for the income tax liabilities of assets inside the trust. The benefit of a grantor trust is the ability to allow those assets in the trust (which are already outside of the grantor’s estate for transfer tax purposes) to then grow essentially tax-free. Paying the income tax liability with funds from the grantor’s estate also reduces the assets that would later potentially be subject to estate tax. Combining income tax planning with transfer tax planning can be a powerful strategy to leverage the overall tax advantages of a dynasty trust strategy.
• Asset protection: From an asset protection perspective, dynasty trusts can be structured as “spendthrift” trusts. This allows them to provide powerful asset protection for the trust’s beneficiaries, including shielding trust assets from creditors of the beneficiaries, divorcing spouses, and other potential liabilities.
• Opportunity for grantors to guide later generations: On a basic level, dynasty trusts appeal to some grantors because they provide the grantor with the opportunity to make a permanent impact on their family for generations to come. Few other planning techniques allow for such a long-term impact on a wealthy family.

Perpetual trusts offer many novel solutions and opportunities for estate planning.

Challenges of Dynasty Trusts

Perpetual trusts offer many novel solutions and opportunities for estate planning. But the strategy can create challenges to administration and future generations due to the permanent nature of a dynasty trust.

• Multiplying trusts and costs: Many dynasty trusts are structured so they split into individual trusts for subsequent beneficiaries. When this occurs over several subsequent generations, it can result in a large and unwieldy structure with enormous legal and accounting costs to maintain. Because this structure can last in perpetuity, it has the potential to spiral into a far different and more complex arrangement than its original grantors may have foreseen. Even without the multiplying number of trusts with each generation, dynasty trusts can be an expensive endeavor to create and administer.
• Problems adapting to changing circumstances: Attempting to “control assets from the grave” is a concept most estate planners caution their clients against. With a structure designed to last forever, changing circumstances and unforeseen events could make the terms of a trust seem onerous and unworkable to future generations. Consider a trust designed to last longer than the common law rule against perpetuities, then in a present-day example we could be talking about a trust formed in the 1800s, or even earlier, that was being administered in the 21st century. For many grantors it can be difficult to imagine the sort of challenges and unforeseen consequences that could arise decades from now. Building flexibility into a dynasty trust is a key concept that cannot be overlooked when planning for future generations.

Providing for future generations with a dynasty trust affords opportunities and poses unforeseen challenges for a grantor to consider in consultation with trusted and knowledgeable advisors.

Conclusion

What is a dynasty trust if not a solution for wealthy families seeking to achieve their generational wealth transfer, tax planning and asset protection goals? The potential to remove assets from the transfer tax system, within the asset-protected structure of an irrevocable trust, and to potentially do so on a permanent basis, is a compelling prospect. The same permanence that makes dynasty trusts powerful planning vehicles can also create challenges, and so it is important to consult with knowledgeable attorneys, accountants and wealth planners before committing to such a strategy.

Providing for future generations with a dynasty trust affords opportunities and poses unforeseen challenges for a grantor to consider in consultation with trusted and knowledgeable advisors.

Comerica’s Wealth Management team has great breadth and depth of experience working with dynasty trusts and administers such trusts in multiple jurisdictions with laws favorable to the formation of dynasty trusts. If you are interested in learning more about dynasty trusts, please ask your Comerica Relationship Manager or request to speak to a Comerica Wealth Management advisor.

¹For purposes of this article, we assume that all persons discussed are US citizen taxpayers; exemption amounts available to non-US citizens are different and beyond the scope of this article.