The benefit of dynasty trusts

by Steven Shane

Nothing lasts forever. For trusts, there is a somewhat arcane law in the United States called the Rule Against Perpetuities which prevents a trust from lasting “too” long. Many states have abolished their Rule Against Perpetuities laws to permit trusts to have indefinite duration, opening the legal door for dynasty trusts. Combined with: (i) steady increases in the federal estate, gift, and generation-skipping transfer tax exemptions (currently USD 12.06 million per person in 2022); (ii) the scheduled sunsetting of the most recent increase which will cut exemption amounts in half at the end of 2025; and (iii) the looming possibility of tax legislation aiming to curtail common tax planning strategies, wealthy families have been creating “dynastic” trusts that are exempt from transfer taxes and protected from creditors often for multiple generations.

A dynasty trust is a type of irrevocable trust which allows the creator of the trust to establish stipulations for how the trustee manages the property held within it, including how much of the assets each beneficiary is to receive. However, for the most part, once a dynasty trust is funded, the creator of the trust no longer has any influence over controlling the assets. A trustee appointed by the creator of the trust controls the assets held by the dynasty trust.

A dynasty trust is an efficient way to protect the assets of a family. While there are many benefits to forming a dynasty trust, three primary ones that come to mind are protection against creditor actions, encouragement of long-term planning, and legal shielding against certain types of taxes.

Forming a dynasty trust can protect the assets in the trust from the creditors of each of the beneficiaries designated by the trust. These trusts typically have spendthrift protection clauses preventing creditor attachment of the assets. Because the trusts are written in a way that prevents trust property from falling into the hands of a trust beneficiary’s spouse, the trust can provide strong protection from a spousal creditor.

When the creator of the trust designs and funds a dynasty trust correctly, the assets assigned to the trust remain exempt from estate taxes, and possibly generation-skipping transfers taxes for all beneficiaries through multiple generations. The compounding effect of tax exemptions for assets assigned to a dynasty trust means a trust can increase in wealth at a substantially faster rate than estates that are vulnerable to taxation. Some dynasty trusts can be formed in states that have more favourable tax statutes and thus can avoid state income tax on trust income.

There are many other flexible strategies practitioners can use involving almost any aspect of a trust beyond those mentioned in this article. The real challenge is striking the right balance between flexibility and finality for each unique client. When done effectively, a long-term trust can be designed to adapt to the future while still preserving the creator of the trust’s intent and purpose.

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