The lasting benefits of a dynasty trust

By Steven Seel, Wealth Strategist & Dan Griffith, CEPA^®, Director of Wealth Strategy

Generation-Skipping Trusts, some of which are also referred to as ‘dynasty trusts,’ are designed primarily to benefit a grantor's descendants by avoiding federal estate tax each time one generation transfers wealth to the next generation. The dynasty trust is one of the more robust planning tools for those with ultra-high-net worth estates. Properly structured, a dynasty trust may also protect future generations from creditors.

History of dynasty trusts

In 1976, the IRS recognized that taxpayers used lifetime trusts as a method for children to navigate federal estate tax regulations and created the separate generation-skipping transfer tax (GST). In 1986, Congress retroactively repealed the 1976 version of the GST and created the current version. This imposed an additional tax on the transfer of assets to ‘skip persons’ who are more than one generation younger than the transferor, such as grandchildren and more remote descendants, or someone at least 37½ years younger than the donor. A GST tax exemption that is initially equal to the federal estate tax exemption ($13,610,000 in 2024 and indexed for inflation) is granted to each individual^†. A taxpayer who makes a gift to a properly structured dynasty trust, can leverage the GST tax exemption, allowing the trust to remain exempt from both estate and GST taxes for the entire term of the trust –potentially over many generations under the current tax laws.

Structure

Many dynasty trusts create separate shares for each child of the grantor. During the child's lifetime, the trustee can use the income and principal of the dynasty trust for the health, education, maintenance, and support of the child. When the child dies, regardless of age, the assets usually remain in trust for their descendants. This scenario repeats for each generation for as long as the dynasty trust is permitted to run under applicable state law.

To aid flexibility, each current beneficiary can be given a non-taxable limited power of appointment (exercisable at death) over the trust's assets. This allows the current beneficiary to, in essence, revise the terms of the trust, including changing the beneficiaries in whatever way the grantor might permit.

Traditional distribution

Assume you leave $1,000,000 of your estate to your child. The child spends all of the interest and dividend income that the investments produce on an annual basis but does not expend principal. When your child dies, the funds will transfer to their children. If those funds were subject to estate tax at the current rates, the grandchild would only receive $600,000 after paying a 40% estate tax ($1,000,000 minus $400,000). When your grandchild dies, that $600,000 could similarly shrink to $360,000 when passed on to the next generation. By the time your great-grandchildren are involved, the $360,000 is worth only $216,000 (for simplicity, we assume no growth). Even though the principal is never touched, it’s still diminished by the tax hit at each generation.

Using a dynasty trust

Instead, you can fund a dynasty trust with the same $1,000,000 either during your lifetime or at your death. Each successive generation has use of the interest and dividend income and even access to principal if needed, but the trust’s assets continue to accumulate without the potential tax hit at each successive generation.

The table below outlines the significant potential increased earnings when a $10 million inheritance to the first generation is held in a dynasty trust over the course of just two generations (30 years each), compared to a trust without dynastic provisions. The trustee may distribute assets to the beneficiaries as described by the terms of the trust and make investments as permitted by the document and state law. Based on this example which assumes after-tax growth of 4% and federal estate tax at 40%, the dynasty trust holds an additional $69,325,615 for use by the fourth generation over and above the trust without dynastic provisions.

In addition, the dynasty trust can be designed under the laws of most states to add the benefit of asset protection for each of the beneficiaries, helping to ensure that the trust assets are shielded from potential divorcing spouses, creditors, or other financial predators. If structured as a grantor trust for income tax purposes, a dynasty trust can allow the grantor to pay the income taxes on the assets inside the trust, essentially fostering tax-free growth. Finally, the dynasty trust can ensure that the funds will stay within your family's bloodline generations into the future. Your legal and tax advisors can help you determine what structure is best for you and your unique situation.

Next steps

A dynasty trust can be an excellent solution for ultra-high-net worth families seeking to achieve generational wealth transfer, tax planning, and asset protection goals. Although dynasty trusts have many benefits, it’s important to weigh their pros and cons with your trusted advisors such as your attorneys, accountants, and other wealth advisors before moving forward with this strategy.

Getting the advice you may need

Growing and securing your wealth and legacy might be achieved by incorporating a dynasty trust in your financial plans. Huntington Private Bank advisors can help you determine whether a dynasty trust is right for you. Work with your estate planning team to see if a dynasty trust is right for you. To learn more, please contact your Huntington Private Bank team to see how we can help, or find a Huntington Private Bank Office near you.