What Is A Dynasty Trust And Are There Disadvantages?

Written by
Amber Hobert
Published on
July 9, 2024
Table of Contents

Dynasty Trusts Explained

Are you considering transferring your wealth to your descendants? This is a great way to ensure that your generations benefit from your wealth. One of the problems most families face is not having a well-developed asset protection program to transfer their wealth.

This always creates a lot of issues whereby you find a lot of court cases regarding sharing of wealth. You also find that many people prefer to transfer wealth as gifts to the younger individuals in a trust instead of passing down their assets outright. The strategy of giving your assets to a trust usually has some advantages, such as tax planning, asset protection, and control of the assets.

You have many options when you are creating a trust, and it is necessary to select the best choice for your family. This article looks at dynasty trusts, what they entail, and some of the disadvantages involved. 

What Does a Dynasty Trust Involve?

A dynasty trust, also referred to as a perpetual trust, is a wealth transfer strategy that allows you to transfer wealth from one generation to another. It is a powerful method since it does not trigger transfer taxation like a gift or estate tax. Dynasty trusts are irrevocable trusts with no set termination date.

The trusts usually last for the duration there are assets in the trust. As a revocable trust, it means that a dynasty trust cannot be revoked or changed. If you are selected as the grantor, you have the authority to make the rules for the trust depending on how lax or strict you want the regulations to be.

Once you fund the dynasty's trust, you can never alter its terms and conditions. The beneficiaries cannot change them either. So, as you plan to create a trust, it is essential to be careful in the process. If you decide to take a more lax approach to the generation wealth plan, you can choose one beneficiary to serve as your trustee.

However, most people usually choose financial institutions such as banks to be the trustee of their dynasty trust. The trustee takes full responsibility for managing and distributing the dynasty trust assets according to the outlined terms and conditions. When the last beneficiary dies, the next generation takes the beneficiary's role, continuing the process.

Why is it Necessary to Use a Dynasty Trust?

It is essential to create a dynasty trust to ensure that you leave your wealth in safe hands, and it is passed down to your future generations. The trust guarantees that your wealth is available to all your generations and is never taxed. The absence of taxation means that your wealth does not reduce. The generation-skipping transfer tax is usually levied besides the estate tax on all the assets passed to individuals from one generation to the other.

As a result, it allows you to save a significant amount of money in the form of taxes. Since this is an irrevocable trust, once all the assets are in the trust, they avoid all the taxable events allowing a great compounding power. This is more important if you use tax-free investments. According to the current tax and trust laws, dynasty trusts are subject to estate taxes only once.

This makes it grow faster with time. If you fund the trust for many years, it also means that you get more tax exemptions that are allowed by the tax cuts and jobs act. If you are a grantor, dynasty planning permits you to decide how the wealth should be released to the next multiple generations. This makes it possible for you to determine the amount and the situations that the wealth can be released.

For instance, you can distribute the wealth to a beneficiary when they attain a certain age or complete the required milestones such as not using drugs or college completion. You can arrange the payout entirely or decide to parcel out assets over the different generations. A dynasty trust provides asset protection to all your future generations.

Since it is an irrevocable trust, you can create it to prevent creditors from using the assets to settle the beneficiaries' debts. Thus, a dynasty trust guarantees that your wealth goes to those whom you want to receive your assets. The trust also helps prevent one of the beneficiaries' spouses from claiming the assets after a divorce.

Who is a Dynasty Trust Meant For?

A dynasty trust is an excellent option for all people with taxable estates. The states/districts allowing dynasty trusts include Delaware, Alaska, District of Columbia, Illinois, Hawaii, Idaho, and South Dakota. The trust is beneficial to them since it helps minimize and eliminate transfer tax for them and new generations to come. If you are a family business owner, this is the best trust for you.

How Do Dynasty Trusts Help the Beneficiaries?

If you create a dynasty trust well, it means that the assets given to your beneficiaries are protected from their creditors. They are also not subject to sharing in the event of a divorce by the beneficiaries. Your beneficiaries can use all the assets.

Dynasty trusts are better compared to any other life insurance policies that your heirs can buy. Note that the trust assets are not part of your beneficiaries' estates regardless of how they grow in value in the future.

What Control Do You Retain in a Dynasty Trust?

As a creator of the dynasty trust, you can retain some control over the trust property even after you create the trust. For instance, you can retain the ability to fire and hire trustees and alter some of the provisions when your descendants become the trustees. You can also maintain the power to decide on the dynasty trust investment policy.

In addition, you can also have the final word about the trust capital investment or estate plan. Therefore, you can have continued control over all the trust capital in case you get new investment opportunities.

How Beneficiaries Claim Property from Dynasty Trusts

You can design the dynasty trust in various ways. You can structure it to give a beneficiary total control over the property. Doing this reduces the restrictions placed upon the beneficiaries on how to use the property. For instance, depending on your preference and on specific circumstances, you can choose one beneficiary as the sole trustee of the dynasty trust for their benefit.

However, if you give the beneficiary a lot of control over the dynasty trust assets, the assets may also have limited protection from the beneficiary's creditors. There are other dynasty trusts with more stringent terms. These trusts can have a professional trustee to make sure that the beneficiaries do not abuse their accessibility to the wealth. The control structures are usually varied and have more sophisticated plans like family councils that allow families' insights into the trust administration without allowing a single beneficiary to have sole control of trust distributions.

Regardless of the type of distribution scheme in dynasty trusts, most of them are created hoping that the distribution will be conducted when the listed beneficiaries can use the wealth.

How Much Does it Cost to Setup a Dynasty Trust?

Creating a dynasty trust in South Dakota can be challenging. This is a complex legal document that needs a lot of time and resources to complete. Thus, if you want to create a dynasty trust, you need help from estate planning attorneys. You need time to discuss who will be the trustees, the assets to be used, and how the dynasty trust can be altered.

It is also good to remember that most states in the United States recognize dynasty trusts with an expiry. The good thing is that a dynasty trust in South Dakota can last forever. Ensure that you budget for setup costs including paying your attorney. This is worth it as it helps in avoiding dynasty trust issues that may arise if you try to execute the document yourself.

Disadvantages of a Dynasty Trust

There are several pros and cons of dynasty trust. Here are some of the notable cons to understand before you can design a dynasty trust.

No Flexibility

A trust with a fixed duration allows for easy adjustments of the terms to move with the changing conditions. Dynasty trusts lack flexibility. By their nature, the trusts exist for many generations after your death.

So, it means that your ultimate goals and wishes may not be carried out in the long run. This is unlike other trusts whereby you can easily adjust the agreement's provisions to reflect changed circumstances.

Lack Outright Distributions to Your Heirs

The final consideration is that if you decide to create a dynasty trust, all your intended beneficiaries will not receive traditional inheritance under this trust. This is the case because your trustees are held to the distribution standards specified in the trust. This can cause frustrations to the beneficiaries who maintain that they should get an inheritance after your demise.

Prolonged Fiduciary Roles

A dynasty trust can last in perpetuity. This means that it may outlive all the beneficiaries and the initial trustee. One of the solutions is to name a professional fiduciary such as your bank's trust department. Your bank might not outlive your trust, but it is highly likely to outlive your beneficiaries and trustee.

Need to Design a Dynasty Trust?

Opening a dynasty trust requires a lot of time and planning. To guarantee that you do not make any mistakes, you need to work with the best professionals to help in the process. The right financial advisors and trust attorneys can take you through the process and ensure that you create a trust that will be valuable to your multiple generations.

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