Estate planning can help you manage your investments and other assets to minimize taxes during your lifetime and beyond. A dynasty trust is one vehicle you can use to create a financial legacy for multiple generations. Here’s more on what a dynasty trust is, how it works and its potential benefits.
What Is a Dynasty Trust?
Trusts, in general, manage assets that you own and/or plan to leave to someone else. Trusts tend to vary in their longevity. A typical living trust‘s terms may stand during your lifetime and that of your beneficiaries. Ideally, a dynasty trust remains in effect for a much longer time period. It could stretch across generations of your family.
For example, the immediate beneficiaries of the trust may be your children. But their children and children’s children could continue to benefit from the trust. Like other trusts, a dynasty trust has a trustee that’s responsible for managing assets according to your wishes. Institutions consider dynasty trusts irrevocable. As a result, once you place assets in the trust, you can’t remove them.
Benefits of a Dynasty Trust
There are several reasons to consider a dynasty trust if you have substantial assets that you want to pass on. The main advantages center around dynasty trusts taxation.
Assets in a dynasty trust can avoid federal estate tax if they fall below the federal exemption limit. For 2020, the exemption limit is $11,580,000. If you have assets above that limit, you could transfer them to the trust and only pay the estate tax at the time of transfer. No further estate tax would apply as long as the money remains in the trust.
That could be a huge advantage if you’ve amassed a lot of wealth and you want to insulate your children, grandchildren and subsequent generations from estate tax. Income taxes do still apply to assets held in a dynasty trust but you can manage tax liability with proper asset placement. For example, if you have both dividend- and non-dividend-paying investments, you’d want to keep the ones that pay dividends out of the trust to minimize capital gains tax.
Aside from tax benefits, dynasty trusts also offer an advantage when it comes to asset protection. Assets in a dynasty trust belong to the trust, not the beneficiaries or the grantor of the trust. That means that creditors can’t attempt to attach those assets to collect on outstanding debts. A dynasty trust would allow you to shelter assets against creditor lawsuits during your lifetime and your beneficiaries’ lifetimes.
Generally speaking, trusts also allow you to avoid the probate process. Normally if someone passes away, any assets not held in trust have to go through probate. The executor of the estate is responsible for rounding up assets, paying off any lingering debts and distributing the remainder of the estate to the decedent’s heirs. Assets in a dynasty trust are exempt from probate.
Dynasty Trust Downsides
The biggest drawback of setting up a dynasty trust is that it’s an irrevocable trust. Once you put assets into the trust, they have to remain there. That could be problematic if, for some reason, you decide you don’t want those assets in the trust. And your beneficiaries can’t alter the terms of the trust later on.
There can also be issues with a dynasty trust if the person or entity you choose to act as trustee doesn’t follow through on your wishes. While trustees are subject to fiduciary standards, that doesn’t always guarantee that they’ll act legally and ethically. If a trustee abuses their position and authority, that could directly impact the assets in the trust and your overall financial legacy.
Setting Up a Dynasty Trust
Creating a dynasty trust is a bit more complicated than setting up a regular living trust. It’s helpful to work with an estate planning attorney to create the trust and transfer assets. Putting together a dynasty trust can require significant financial acumen. But generally, setting up a dynasty trust involves:
- Determining which assets will be transferred to the trust.
- Naming beneficiaries to the trust.
- Selecting a trustee and successor trustee(s).
- Determining how assets in the trust should be managed by the trustee.
- Funding the trust.
Funding the trust simply means transferring ownership of assets. So if you want to place the real property in the trust, for example, you’d have to sign the deed over to the trust.
When creating a trust, consider the cost of doing so. If you’re working with an estate planning attorney, you’ll have to pay their fee for setting up the trust. But there are also ongoing fees to be aware of, including the fee paid to the trustee and fees paid to prepare tax returns for the trust.
Who Is a Dynasty Trust Right For?
A dynasty trust is typically better suited to high-net-worth individuals who have significant assets they want to leave for future generations. You may benefit from a dynasty trust if you’re looking for a way to protect assets from creditors and/or ensure that your financial values continue to be practiced by your family members.
On the other hand, a dynasty trust likely wouldn’t make sense if you don’t have as much wealth to go around or you don’t need the trust to last for several decades. You could still benefit from setting up a revocable living trust, which would allow you to make changes to the terms of the trust while you’re still living.
The Bottom Line
A dynasty trust can be a valuable estate planning tool for wealthy investors. However, its value may depend on your assets and goals for minimizing estate taxes. Consider talking to an estate planning attorney. They can help you decide whether to include this type of trust in your asset management plan.
Estate Management Tips
- Consider talking to your financial advisor about the pros and cons of using a dynasty trust to manage wealth. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When mapping out asset allocation, it’s important to consider the best ways to minimize taxes. For example, you may consider investing in tax-efficient exchange-traded funds in a taxable brokerage account. It might make more sense than putting them in a tax-advantaged IRA. Tax-loss harvesting may also keep investment taxes at bay. This involves selling off assets at a loss to offset capital gains. If you’re using a robo-advisor, see if it includes automatic tax loss harvesting.
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