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What is a Dynasty Trust?

Estate Planners | Monday, August 15th, 2011

A dynasty trust is a type of generation-skipping trust that can provide substantial savings on estate tax. When you consider the fact that estate tax can climb to a rate that is as much as fifty-five percent, and that each generation will have to pay estate taxes, you could hypothetically save up to eighty percent of your estate throughout the course of three generations. For each one dollar that you leave behind when you die, a death tax or estate tax of fifty-five percent will bring the value of that dollar down to just forty-five cents before your children get their hands on it. Now if your children have that same dollar when they die, then your original dollar will now be worth twenty-one cents. To see that loss in the bigger picture, consider this. To pass a million dollars on to your grandchildren, you would need to begin with five million passed on to your own children. While it may seem unfair, it is, nonetheless, true.

The dynasty trust is a very effective remedy to this situation that helps guard against losing a significant amount of your estate to estate tax so that it can keep working for your beneficiaries. The advantage of a generation-skipping trust is greatest during your lifetime. After property or assets have been transferred into a dynasty trust, all appreciation and amassed income that may be generated by the property within the trust up until your death is exempt from estate tax. Further, to avoid gift tax during your lifetime, you can choose to fund the trust only to the extent of the exemption transfer with the remainder funded upon death. There is another big advantage to funding the lifetime dynasty over the course of a lifetime. Since the trust is an irrevocable trust, no future changes or modifications to the estate tax law will affect it.

Typically, your children will be the preferred beneficiaries for a dynasty trust. When your last child dies, the grandchildren (or sometimes great grandchild) then become the preferred beneficiaries. Like any other trust, a trustee will control the trust, and this person can utilize income of the trust or from the trust’s principal for the beneficiaries benefit. When a dynasty trust is drafted, you are in control of the amount of discretion that the trustee will have. You can also choose to allow for beneficiaries to be in control of the assets if you wish.

A dynasty trust must only be funded with particular kinds of assets. The Internal Revenue Service taxes dynasty tax income heavily. Suitable choices for placing in a dynasty trust include tax-free municipal bonds, cash-rich life insurance, and non-dividend growth stocks.

Some folks elect to use the dynasty trust as an irrevocable life insurance trust. This means that the trust is funded with insurance on the life of the grantor. In this instance, when the grantor dies, the proceeds of the life insurance policy pay any estate tax on other assets within the estate. (A cash-rich life insurance can also provide an immediate death benefit, and is considered to be “self-completing”).

Although the dynasty trust is often the choice of those with large estates, this is also a useful trust for more modest estates. For those families where a child likely have a large estate themselves (because they have a good income or are in a profession where they will make a lot of money), then the dynasty trust is the perfect estate tool to help deal with future problems that might arise if this child inherits your estate and already owns a large estate.

Discuss dynasty trusts with your estate planner to find out if this is the best trust for your particular circumstances.

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