A dynasty trust (“DT”) is an irrevocable trust that takes advantage of the estate tax, gift tax, and the generation-skipping transfer tax exemptions to pass assets for as long as state law permits. In Delaware and 17 other states, that is forever. In Nevada that is for 365 years. Most trusts provide for mandatory distributions, such as one-third at ages 25, 30 and 35. By contrast, a DT gives the trustees discretion to distribute principal and income as needed to beneficiaries. This allows the trust to grow for future generations and is protected from estate tax and creditors. These trusts can be created while the parents are alive, for example as a children’s trust to own a life insurance policy or to receive gifts of limited partnership interests, or after the parents are dead, to hold assets received from the parents’ estate.
Currently the estate tax and gift tax exclusion and the generation skipping transfer tax exclusion are $5.12 million per person. This will go down to $1 million on January 1, 2013. This means that if the assets included in the trust exceed the $5.12 million per person, the person funding the trust will still be taxed on the excess. One of the benefits of a DT is that since it is an irrevocable trust, future tax law changes will not affect the trust. Therefore, there is a great deal of incentive to create a dynasty trust now while the exclusions are high. Additionally, the growth of the investment in the DT is not subject to estate taxes. A savvy investor can make a $10 million investment grow to $100 million or more.
One of the biggest incentives of the DT is that distributions to beneficiaries from the trust are exempted from the estate tax. Thus, if the assets are below the exclusion amount ($5.12 million per person), the person creating the trust does not have to pay taxes upon the creation of the trust and the beneficiaries do not have to pay estate taxes upon the distribution of the trust assets. One thing to note, however, is that distribution of income would still subject beneficiaries to income tax on the distribution which may be a huge burden. One way around this may be to fund the DT with tax free assets like tax free municipal bonds or cash rich life insurance policies.
