The purpose of estate tax planning is to maximize the assets you pass on to future generations by minimizing gift and estate taxes. Estate-tax strategies revolve around the use of irrevocable trusts. This article discusses the most common types of irrevocable trusts that are used to minimize gift and estate […]
The term “dynasty trust” describes any irrevocable trust that is designed to hold assets for multiple generations. They are set up in states that have abolished or significantly curtailed the traditional “Rule Against Perpetuities,” which historically limited the maximum duration of trusts to about 100 years. Intentionally defective grantor trusts, non-grantor trusts, and irrevocable life insurance trusts all can be — but don’t have to be — structured as dynasty trusts. In this article, we’ll explain how dynasty trusts work, address the benefits and tradeoffs, and explain who should consider taking advantage of this strategy.
Setting up and administering a dynasty trust is actually simple. A dynasty trust, like any trust, is a legal arrangement in which one person (the grantor) transfers property to a person or entity (the trustee), who holds legal title to (control over) that property for the benefit of another person (the beneficiary). Think of it as a contract between the grantor and the trustee for the beneficiary’s benefit. The grantor gets to dictate the terms of the trust.
Once the trust agreement creating the trust has been signed, the grantor gifts assets to the trust. A dynasty trust can hold any assets, from stocks, to crypto, to real estate. The trustee invests and manages those assets. The trustee also has the ability to make distributions to the beneficiaries. When and how much the trustee distributes will depend on the terms of the trust and — if the trustee is given discretion — the trustee’s own judgment. In general, it’s more tax efficient for the trust to retain assets than it is for the trust to distribute them. That’s because assets inside of a dynasty trust are typically exempt from estate tax, gift tax, and generation-skipping transfer (GST) tax. To understand why, we’ll need to discuss these taxes in more detail.
The estate tax is a tax on the assets that a person leaves to their heirs when they pass away. The estates of U.S. citizens and residents are taxed on all of their worldwide assets — including real estate, retirement accounts, brokerage accounts, crypto, intellectual property, and whatever else a person owns. The federal estate tax rate is a flat 40%, and any tax is due within nine months of a person’s death.
Charitable gifts and gifts to surviving spouses are not subject to estate tax (though the property gifted to a surviving spouse will be part of the surviving spouse’s estate when he or she dies). Further, each individual has a basic exclusion amount, sometimes called an exemption. In 2024, the exemption is $13.61 million. It is adjusted for inflation, so it usually increases on January 1. The estate tax exemption is expected to be around $14 million in 2025, but under current law it is scheduled to be cut in half to about $7 million on January 1, 2026.
The federal gift tax is a tax on gifts made during the transferor’s lifetime. It applies when the transferor is a U.S. citizen or resident. It also applies to non-resident aliens who transfer U.S. situs property, such as a house in Florida. Like the federal estate tax, it is levied at 40%, and it shares the same $13.61 million exemption amount with the estate tax. So, if you use $3 million of your gift tax exemption during your lifetime and you die in 2024, your estate tax exemption will be $10.61 million.
The gift tax and the estate tax are functionally a single, unified tax: the gift tax applies to lifetime gifts and the estate tax applies to transfers upon death. But there’s a separate, second layer of federal tax, called the generation-skipping transfer (GST) tax, that applies to transfers to members of generations after your children’s generation (grandchildren, for example). The generation-skipping transfer tax also applies to transfers to non-family members who are 37.5 years or more younger than the donor. This tax is also levied at a rate of 40%, which means transfers to your grandchildren could be subject to an effective tax rate far in excess of 50%, even if you live in a low-tax state. Like the gift and estate tax exemption amount, the GST tax exemption amount is $13.61 million in 2024.
The federal estate, gift, and GST taxes are serious obstacles to intergenerational wealth transmission. Dynasty trusts help minimize those obstacles in a few important ways.
First, assets gifted to dynasty trusts are outside the grantor’s estate. That means that any future appreciation is outside the grantor’s estate, too. For example, imagine that Mark, a 40-year-old from New York, gifts a $10 million building to a dynasty trust. If Mark dies fifty years from now, when that building is worth $75 million, he will have transferred an additional $65 million ($75 million – $10 million) to the dynasty trust without making any additional gifts. The effective estate tax rate for New York residents is currently 49.6%. If Mark dies a New York resident, getting this appreciation out of his estate will save Mark’s heirs more than $32 million ($65 million * 0.496).
Dynasty trusts also lock in the current gift tax and GST tax exemption amounts, which are set to be reduced by 50% on January 1, 2026 (from about $14 million to about $7 million). As of this writing, in summer 2024, many high-net-worth people are racing to set up dynasty trusts for this very reason!
Finally, dynasty trusts are important GST tax planning tools in general. Typically, people gift assets equal to all or a portion of their lifetime exemption amount to a dynasty trust. By doing so, they use gift tax lifetime exemption but also — and this is important — allocate GST tax exemption to the trust. That means that the trust is exempt from GST tax for as long as the trust lasts. Dynasty trusts are set up in states that allow trusts to last for a long time (in some cases, forever). That means that the assets in a dynasty trust will never be subject to the 40% GST tax.
The maximum length of a dynasty trust is the main feature that distinguishes it from any other irrevocable trust. The maximum length depends on the laws of the state in which the trust was established. A South Dakota trust can last forever and we at Valur offer these types of trusts. In Colorado, trusts can last up to 1,000 years. In Nevada, trusts can last up to 365 years. A total of 28 states have abolished or substantially modified the traditional Rule Against Perpetuities, allowing trusts to last for longer than the 90-100 year period that was permitted historically. Of course, in some cases, it may not make sense for a trust to last 500 years. The trustee may decide to distribute assets to the beneficiaries in 200 years instead!
In the United States, litigation is one of the biggest risks to wealth preservation. A lawsuit can undo years of savvy financial management. Here, dynasty trusts can help. Because a dynasty trust is a separate legal person, it is generally not liable for actions taken by a trust’s grantor or beneficiary. So the grantor’s or beneficiary’s creditors won’t be able to access the trust’s assets even if they win their lawsuit against the grantor or beneficiary. In addition to protecting assets from lawsuits, dynasty trusts can help shield inherited assets from a divorcing spouse.
Dynasty trusts have enormous gift tax and GST tax advantages, and they’re creditor protected to boot. But it’s important to understand that funding a dynasty trust (or other type of irrevocable trust) is essentially irreversible. You might be able to borrow money from the trust tax-free, depending on how the trust is structured. But you can’t simply change your mind and take the money back after you’ve already set up the trust without facing some adverse tax consequences. So you need to be sure that you want to fund a trust for the benefit of your loved ones before you actually do it.
Further, it might not make sense for people who are well below the gift tax exemption amount to set up a dynasty trust, because their heirs probably won’t have estate tax or GST tax issues to deal with in the first place. For these people, a more conventional revocable living trust (which doesn’t have any tax benefits, but is very flexible) might be a better fit.
Should you set up a dynasty trust? It depends on your goals and your level of wealth. If you expect to be over the estate tax exemption amount when you die, you’re focused on saving your heirs taxes, and you have at least some spare liquidity, then it makes sense to set up a dynasty trust today. The sooner you set it up, the more taxes you’ll save your heirs. On the other hand, if you don’t think you’re ever going to be over the estate tax exemption amount, or you’re not particularly focused on saving your heirs taxes, or you don’t have any spare liquidity right now, then you probably should not set one up right now.
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From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $3 billion in additional wealth for our customers. If you would like to learn more, please feel free to explore our Learning Center. You can also see your potential tax savings with our online calculators or schedule a time to chat with us!
