A dynasty trust can preserve substantial amounts of wealth — and shelter it from federal gift, estate and generation-skipping transfer (GST) taxes — for generations to come. Leveraging your GST tax exemption is a key to the success of a dynasty trust.
The good news is that this trust type is now more appealing than ever thanks to the current record-high GST tax exemption ($11.58 million for 2020). However, that amount is due to drop to $5 million, subject to an adjustment for inflation, at the end of 2025, so that’s an important fact to keep in mind as you consider whether a dynasty trust is right for you.
Leveraging the GST tax exemption
A dynasty trust allows substantial amounts of wealth to grow and compound free of federal gift, estate and GST taxes, providing tax-free benefits for your grandchildren and future generations. The longevity of a dynasty trust varies from state to state, but it’s becoming more common for states to allow these trusts to last for hundreds of years or even in perpetuity.
Avoiding GST tax liability is critical to a dynasty trust’s success. An additional 40% tax on transfers to grandchildren or others that skip a generation, the GST tax can quickly consume substantial amounts of wealth. The key to avoiding the tax is to leverage your $11.58 million GST tax exemption.
For example, let’s say you haven’t used any of your $11.58 million combined gift and estate tax exemption. In 2020, you transfer $10 million to a properly structured dynasty trust. There’s no gift tax on the transaction because it’s within your unused exemption amount. And the funds, together with all future appreciation, are removed from your taxable estate.
Most important, by allocating your GST tax exemption to your trust contributions, you ensure that any future distributions or other transfers of trust assets to your grandchildren or subsequent generations will avoid GST taxes. This is true even if the value of the assets grows well beyond the exemption amount or the exemption is reduced in the future.
Regardless of the tax implications, there are several nontax reasons to set up a dynasty trust. First, you can designate the beneficiaries of the trust assets spanning multiple generations. Typically, you might provide for the assets to follow a line of descendants, such as children, grandchildren, great-grandchildren, etc. You can also impose certain restrictions, such as limiting access to funds until a beneficiary earns a college degree.
Second, by placing assets in a properly structured trust, those assets can be protected from the reach of a beneficiary’s creditors, including claims based on divorce, a failed business or traffic accidents.
Steps for building a dynasty trust
A dynasty trust can be established during your lifetime as an inter vivos trust or as part of your will as a testamentary trust. An inter vivos transfer to a dynasty trust may have additional benefits associated with transferring assets that have greater appreciation potential out of your taxable estate.
After creating the trust, you must determine which assets to transfer to it. Because the emphasis is on protecting appreciated property, consider funding the trust with securities, real estate, life insurance policies and business interests. Retain enough assets in your personal accounts to continue to enjoy your lifestyle.
Finally, you must appoint a trustee. Your choices may include a succession of family members or estate planning professionals. Consider, also, whether to include a reputable trust company with a proven track record as one of the successors, as opposed to ultimately assigning this duty to family members who aren’t yet born.
Is this trust right for you?
By leveraging your GST tax exemption, a dynasty trust can grow and compound transfer-tax-free for decades to benefit your grandchildren and future generations. However, a currently effective dynasty trust is irrevocable. This means that you’re unable to revise it should life changing events, such as a divorce, take place. Contact us for help.
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