Building wealth is one thing; keeping it intact across generations is another challenge altogether. In a study conducted by The Williams Group, a wealth consultancy, who tracked 3,200 families over 20 years, found that 70% of families lost their fortune by the second generation. Only 10% of those studied kept it by the third generation, citing family disagreements and disputes over business or properties as a common theme. So, how can one kick the second or third-generation curse? One smart approach is through the use of trusts. However, not all trusts are created equal, and most terminate after a set amount of time, releasing their assets into the hands of those waiting beneficiaries. One type of trust that offers unique features for multi-generational wealth preservation is the Dynasty Trust.
What is a Dynasty Trust?
A trust is simply a legal arrangement that transfers assets to a trust where they can be managed by a trustee. The beneficiaries of the trust are eligible to receive income and distributions from the trust according to its stipulations.
A Dynasty Trust operates similarly but uses specific mechanisms to help preserve and grow wealth across multiple generations. Unlike traditional trusts, which may expire after a few decades or a few generations, Dynasty Trusts can last for hundreds of years, a thousand years, or even forever, such as Delaware Dynasty Trusts.
Why Use a Dynasty Trust?
Protection From Creditors
Assets that remain in your personal name are subject to seizure if a lawsuit or debt collection arises, but assets that are held in a properly structured trust are generally shielded from such risks. This means that if someone in your family faces financial difficulties or legal issues down the road, the wealth stored in the Dynasty Trust remains safe and intact, out of reach from creditors if structured correctly. For example, your great-grandchild could declare bankruptcy and lose their assets, but they might still be able to receive income and distributions from the trust once the bankruptcy proceeding is closed without fear of seizure, helping ensure they never fall destitute.
Protection from Beneficiaries
Reckless spending and poor management can erode a fortune more quickly than anticipated, and beneficiaries may sometimes struggle to manage their inheritance effectively. Upon receiving a substantial inheritance, many can find it difficult to manage their newfound wealth with discipline and savviness.
A Dynasty Trust places control of its assets in the hands of an experienced and reliable trustee rather than relying on the discretion of beneficiaries. The trustee, who could be a trusted advisor or professional fiduciary, manages the trust’s assets and determines when and how to distribute income or principal to the beneficiaries, all while adhering to the trustor’s original intentions as outlined in the trust document.
Dynasty Trusts often include “spendthrift provisions,” which prevent beneficiaries from borrowing against their future inheritance or using it as collateral for a loan. This adds another layer of protection, helping ensure inexperienced heirs cannot access their inheritance earlier than stipulated.
Reduction of Tax Liabilities
The Generation-Skipping Transfer (GST) tax is a hefty tax applied when assets are passed to someone two or more generations below the donor, like grandchildren or great-grandchildren. Fortunately, every individual has a lifetime GST tax exemption. In 2024, this exemption stands at $13.61 million per individual (or $27.22 million for married couples). However, this exemption, like the Lifetime Gift Tax Exemption and Lifetime Estate Tax Exemption, is likely to be reduced by about 50% at the end of 2025 when the Tax Cuts and Jobs Act (TCJA) expires. By setting up a Dynasty Trust, it’s possible to allocate this exemption to shield assets from the GST tax, potentially allowing the wealth to grow and pass with minimized tax implications through multiple generations.
Example 1: Without a Dynasty Trust
You gift $15 million directly to your grandchild. The first $13.61 million is covered by your lifetime GST exemption, so there is no GST tax on that portion. However, the remaining $1.39 million exceeds the exemption and is subject to the 40% GST tax, meaning $556,000 in taxes would be owed. After the tax is paid, your grandchild is left with $14.44 million.
While this direct gift avoids some GST tax, your grandchild now has full control of the money, leaving it exposed to potential risks, such as creditors or poor financial decisions.
Example 2: With a Dynasty Trust
You place $15 million into a Dynasty Trust for your grandchild and future generations. Just like in the first example, $13.61 million is covered by your GST exemption, and $1.39 million is subject to $556,000 in GST tax. After the tax, the trust holds $14.44 million.
The key difference here is that by placing the assets in a Dynasty Trust, the wealth can be better protected. The assets can continue to grow over time, and all future distributions to your grandchild—and even later generations—are shielded from further GST tax. Additionally, the trust structure provides protection from creditors and the immediate whims of your grandchild.
Dynasty Trusts for Business Owners
For business owners, a Dynasty Trust offers distinct advantages. It can hold ownership shares of the family business, ensuring that control stays within the family and is passed seamlessly to future generations. The trust can specify who manages the business, separating ownership from management, so day-to-day operations are handled by designated individuals or professionals. While beneficiaries may not have direct control over the business, they still benefit financially through profit distributions based on their ownership shares held in the trust.
In Conclusion
The levels of asset protection, financial control, and tax efficiency that a Dynasty Trust offers make it a powerful tool in estate planning. However, it comes with its own set of complexities, and if not properly structured, it can create more problems than it solves. That’s why consulting with a fiduciary financial advisor should always be your first step before pursuing any estate planning strategy.
Additionally, there are numerous ways to protect assets and optimize taxes, and a trust is just one of them. If you are curious about how to optimize your own estate plan, reach out to WealthGen Advisors today for a consultation by clicking the button below.
