Family business planning meeting

Compound growth over time — uneroded by taxes — is key to amassing substantial wealth, and that’s where dynasty trusts come in. The term “dynasty trust” is simply tax slang for a trust designed to minimize taxes over multiple generations.

Without dynasty trusts, wealth in excess of the current estate and generation-skipping transfer (GST) tax exemptions ($12.06 million for individuals or $24.12 million for married couples in 2022) is subject to a 40% tax at each generation. Thus, nearly half of a family’s wealth over the exemption amount may be paid to the government in the form of taxes at the first generation’s death, and then again at the second generation’s death, and then again at the third generation’s death and so on.

Dynasty trusts were created to avoid these successive layers of tax. Current rules allow individuals to establish and fund dynasty trusts with up to $12.06 million tax-free. The amount is doubled for married couples. That initial gift — plus future appreciation — can avoid estate and GST taxes for as long as trusts are permitted to last under applicable state law. In some states, that’s forever. But in most states, limits are closer to 90 years.

Last year, Texas modified its rule (the so-called “rule against perpetuities”) to extend the permissible duration of noncharitable trusts to 300 years. (Notably, there is an exception for real property, which cannot be retained in trust for more than 100 years.) This means families who create dynasty trusts in Texas can escape estate and GST taxes for up to 300 years.

The compound growth on those assets over that period can boost family wealth. Furthermore, the trust assets are generally creditor-protected, including in divorce, which is bound to occur at least once over the span of many generations.

Of course, creating a trust meant to last 300 or more years involves multiple considerations. Future beneficiaries may have very different goals and challenges. Family dynamics and laws can change.

To make sure the trust can evolve in the face of unforeseen events, trust creators should build in flexibility. One way of doing so is giving beneficiaries the power to redirect trust assets through powers of appointment.

Another way is appointing trust protectors or advisors and giving them the ability to modify the trust within the bounds of the trust agreement and state law. Sometimes a trust protector’s or advisor’s powers can be extensive and can include the power to correct scrivener’s errors, add or exclude beneficiaries, or change the trust’s situs.

With that in mind, you should carefully consider who you choose as trust protector or advisor and the succession plan for that role.

You should also give that person or entity enough flexibility to adjust for unpredictable circumstances. Along those lines, you may want to incorporate the ability to “decant” the trust, giving your trustees the option of moving the assets from the original trust to a new trust with updated terms without having to go to court. For a number of reasons, this option may be helpful. For instance, trust terms may need to be modernized to account for new types of assets, like the rapidly evolving digital assets of today (think cryptocurrency and NFTs).

In the end, remember dynasty trusts are intended to benefit multiple future generations. Those generations will undoubtedly face different obstacles and have different ideas of money and wealth. Ideally, the trust should have the ability to adapt and preserve hard-earned family assets. If done correctly, dynasty trusts can leave an enduring and significant financial legacy for generations to come.

Michael Lum
Director, J.D.
Aerial view of a local community
Next up

Shared services model pays off for Minnesota State Colleges and Universities