Dynasty Trusts Explained: Passing Wealth Across Generations

For families who want their wealth to benefit not only their children but also grandchildren, great-grandchildren and beyond, a dynasty trust is one option. Dynasty trusts are designed to preserve wealth across multiple generations, potentially reducing transfer taxes and providing long-term management and protection. They’re powerful tools, but they involve complex rules and long-lasting decisions.

What a dynasty trust is

A dynasty trust is an irrevocable trust designed to last for multiple generations, potentially for many decades or even indefinitely, depending on state law. Assets placed in the trust are managed by a trustee and used for beneficiaries according to the trust’s terms, which are set by the person who creates the trust, called the grantor.

Rather than distributing all assets outright to children, who then pass them to their children, a dynasty trust keeps assets in trust across generations. Beneficiaries can receive distributions for purposes the grantor specifies, such as education, health care, housing or starting a business, while the underlying assets remain in the trust.

How dynasty trusts work with taxes

Federal transfer taxes include the estate tax, the gift tax and the generation-skipping transfer tax. Each generation that inherits wealth outright may face estate taxes when they pass it on, if their estate exceeds the federal exemption amount.

Assets held in a properly structured dynasty trust generally aren’t included in each beneficiary’s taxable estate, so they may avoid estate taxes at each generation.

The generation-skipping transfer tax, or GST tax, is a separate federal tax designed to apply when assets skip a generation, such as transfers to grandchildren or to trusts benefiting multiple generations. Each person has a GST tax exemption, which can be allocated to transfers to a dynasty trust. When the trust is funded using the GST exemption, the assets and their future growth can be shielded from the GST tax, regardless of how much they grow over time.

Exemption amounts are set by federal law and can change with legislation. Check current amounts with your tax adviser.

Potential benefits

Assets may avoid estate taxes at each generation, if the trust is structured properly, allowing more wealth to pass to future generations.

Using your GST tax exemption can shield the trust’s assets from the GST tax, potentially for the life of the trust.

Professional management and clear rules for how money is used can help preserve wealth and encourage responsible use. The grantor can set guidelines that reflect family values, such as supporting education or encouraging work.

Potential protection from beneficiaries’ creditors, lawsuits or divorces may be available, depending on the trust’s terms and state law. Because beneficiaries don’t own the assets outright, assets held in a properly drafted trust with spendthrift provisions may be protected from beneficiaries’ creditors in many situations.

Dynasty trusts can also help keep family assets, like a family business or property, within the family across generations.

Where you set it up matters

States have different rules about how long trusts can last. Historically, a legal principle called the rule against perpetuities limited how long trusts could exist, generally to a period tied to the lives of people living when the trust was created plus 21 years.

Some states have eliminated or significantly extended this traditional limit, allowing very long-lasting trusts, sometimes for hundreds of years or indefinitely. States also differ in their state income taxes on trusts, asset protection laws and trust administration rules.

Many families choose to establish dynasty trusts in states with favorable trust laws, even if they don’t live there, often by appointing a trustee in that state.

Things to consider

The trust is irrevocable. Once established and funded, the trust generally can’t be easily changed or revoked. Some modern trusts include provisions, such as trust protectors or decanting options, that allow certain changes in response to changing laws or circumstances.

Choosing trustees and successor trustees is critical. The trustee manages the trust’s assets and makes distribution decisions, potentially for many decades. Families may choose individuals, professional trustees, such as banks or trust companies, or a combination. Planning for successor trustees ensures continuity over generations.

Distribution rules should balance support with encouraging independence. Overly generous distributions might discourage beneficiaries from working or developing their own skills, while overly restrictive rules might prevent the trust from meeting genuine needs. Many grantors include guidance reflecting their values and give trustees discretion to adapt to circumstances.

Setup and administration costs can be significant, including legal fees, trustee fees, investment management and tax filings. Dynasty trusts generally make sense for families with substantial wealth.

Trusts may pay income taxes on undistributed income, and trusts reach the highest federal income tax brackets at much lower income levels than individuals, which affects investment and distribution strategies.

Preparing future generations

A dynasty trust can preserve financial wealth, but many families find that preparing heirs to manage wealth responsibly is just as important. Family meetings, financial education and communicating family values can help beneficiaries understand the purpose of the trust and use it wisely.

Get expert help

Dynasty trusts involve complex tax, legal and administrative rules. Work with an experienced estate planning attorney and tax adviser to determine whether a dynasty trust fits your family’s goals and to structure it properly.