One reason you may set up an estate plan is to ensure that your family will be financially taken care of for many years after your death. One option is the use of a Dynasty Trust, which is created for the purpose of providing future generations of your family with a source of funds that is likely to increase year after year, decade after decade. Therefore, careful planning is required.
Generally, the Dynasty Trust becomes an extension of the grantor’s original living trust after the grantor’s death. When done properly, a Dynasty Trust protects the trust assets from creditors of the beneficiary, judgments against the beneficiary, claims of the beneficiary’s spouse in the event of a divorce, and can shield assets in the trust from being deemed “available resources” in the event the beneficiary needs Medicaid for nursing home care.
Estate Tax Advantages
The biggest advantage of a Dynasty Trust is that it can save your descendants a significant amount of money in estate taxes. The assets you put in the trust (plus any increase in their value over the years) are subject to the federal gift/estate tax just once and applied only when you transfer them to the trust. They are not taxed again, even though multiple generations benefit from them.
In contrast, if you left a very large amount of money directly to your children and did not place it in a trust, that money would be subject to the estate tax at the time it was gifted and then again when your children leave it to their children (your grandchildren). Double taxation, not cool!
It is possible to avoid a tax event by leaving assets directly to your grandchildren so that the federal generation-skipping transfer tax could apply. However, it is important to note that only very large estates, worth more than several million dollars, are subject to federal estate or generation-skipping transfer tax. So, this strategy does not work for everyone.
Tax on Trust Income
It is important to note that income taxes are due on income generated by trust assets. For this reason, well-advised grantors will avoid putting income-producing assets into a Dynasty Trust. Instead, they will fund the trust with stocks that don’t pay dividends or tax-free municipal bonds, as these assets do not produce income. It is also common to transfer life insurance policies to a Dynasty Trust. After the policyholder’s death, the policy proceeds can be used to pay estate tax that’s owed on other assets in the estate.
Disadvantages of Dynasty Planning
The biggest disadvantage of dynasty planning is the lack of future flexibility. Because dynasty trusts are irrevocable, the grantor cannot later change their mind and the grantor’s descendants cannot alter the terms of the trust if/when family or financial circumstances change. As such, an improperly designed Dynasty Trust could, therefore, end up as useless pieces of paper.
When designing a Dynasty Trust, the grantor gets to choose an initial trustee and successor trustees to manage the trust assets and spend them on the beneficiaries’ needs according to the terms set out in the trust – often, an adult beneficiary, a bank or a trust company, and decide who their beneficiaries are and what rights they have - often, the grantor’s children first and then after their deaths the grantor’s grandchildren.
Dynasty Trust provisions can be as specific or broad as the grantor wants. The grantor can also give the beneficiaries power to give away some of the trust assets or leave them to others at their own deaths, which does provide some flexibility for the beneficiaries in the future. Generally, this gifting allowance is advisable for estates with millions of dollars and no concerns for loss of funds in the future. In contrast, grantors with estates that do not contain a lot of current assets may not want this flexibility in order to better preserve and grow funds for multiple generations.
As with any other legal document, using a DIY or pre-printed trust is risky and you should always consult with an estate planning attorney to ensure your specific goals and all legal requirements are met.
If you are interested in learning more about dynasty estate planning tools and protecting your family for generations to come, please contact me today!