The term “dynasty trust” sounds like something that could only be useful for aristocrats or folks with more money than they could possibly spend in a lifetime. Jeff Bezos might need a dynasty trust. Or Bill Gates. But most estate plans don’t need that sort of thing, right?
Well … it’s not quite so simple. This article therefore focuses on using dynasty trusts in Florida starting with some basics and moving to discuss more specific benefits that may be gained even with relatively modest estates.
Dynasty Trusts for Average Florida Estates
Many more Florida estate plans could benefit from a dynasty trust than you might think. While it’s true that there is an asset threshold before dynasty trusts start to make sense, it’s not anywhere near the Jeff Bezos, Bill Gates level. The more important factor is what you are trying to accomplish with your estate plan. Dynasty trusts are a useful tool, designed for a specific purpose – keeping valuable assets in the family over multiple generations. If that’s your goal, a dynasty trust might be just what the doctor ordered, even if you have a moderate-sized estate.
What is a Dynasty Trust?
A dynasty trust is a trust used in estate plans to transfer wealth between generations while minimizing exposure to transfer taxes. If used for this purpose, dynasty trusts are created as an irrevocable trust (vs. revocable trust) in Florida, which means, once the trust is created, the grantor (the person who funds the trust, a/k/a the “settlor”) no longer controls the assets held in trust. Instead, the declaration of trust (the legal document that creates the trust) designates a trustee to manage the assets and make distributions to beneficiaries under terms laid out in the declaration. With that said, a dynasty trust may also be reserved as part of a revocable living trust in Florida, or even as a Florida testamentary trust which is part of a Florida last will and testament, meaning that the dynasty trust becomes effective (vested) upon the death of the last surviving trustmaker OR testator of the last will.
Unlike some trusts used in estate planning, dynasty trusts are, by definition, long-term. In Florida, they can be arranged to last more than 360 years, which, in practical terms, makes the trust essentially perpetual. Of course, a dynasty trust does not have to last that long and can be limited to just a couple generations. The fundamental idea is that you want more than just the next generation to benefit from the assets held in the trust.
How do Dynasty Trusts Work?
A dynasty trust commences when the grantor executes a declaration of trust and transfers assets into the trust. As mentioned above, dynasty trusts can be either testamentary (created by will) or inter vivos (created while the grantor is still alive) as an irrevocable or revocable trust. The key is that to remove assets from the grantor’s taxable estate, the trust must be inter vivos and irrevocable at the time of the transfer of assets to the trust.
Along with appointing a trustee of the Florida trust, the declaration defines the situs (the location where the trust is primarily administered) and the governing law. Florida is an attractive jurisdiction due to its 360-year Rule against Perpetuities and because there is no state income or estate tax. Most other states don’t allow dynasty trusts to persist for quite so long, and many have state income and estate taxes that chip away at the value of the trust. Between the friendly tax structure and the extended timespans, Florida offers a highly advantageous legal framework for dynasty trusts.
A grantor can fund a dynasty trust with cash, securities, real estate, or pretty much any other valuable estate asset that does not have to be held by a natural person. Once in the trust, assets are controlled and administered by the Florida trustee. This could mean investing cash, managing and leasing real estate, or voting on behalf of the trust if it owns stocks. Obviously, grantors should be careful to select a trustee who is competent and trustworthy. If the trust’s situs is Florida, the trustee should be someone familiar with Florida trust law. Due to the long-term nature, a dynasty trust declaration should include a mechanism for appointing capable successor trustees.
A trust’s “beneficiaries” are the people designated to receive the benefit of the trust’s assets in the form of distributions made by the trustee as directed by the declaration. A dynasty trust might name the grantor’s children as beneficiaries during their lifetimes, with grandchildren becoming beneficiaries afterwards or when they reach adulthood. Depending upon how well-funded the trust is and how well investments perform, this pattern could be repeated through numerous generations. A declaration can also give beneficiaries “Florida power of appointment,” which means they get to decide who receives their beneficial interests after death.
When creating a dynasty trust, the grantor has wide latitude in directing distributions, which can be comprised of trust income, principal, or a combination of the two. Under a “strict” approach, the trustee makes periodic distributions in a precise amount and everything that is left over benefits future generations when they become beneficiaries. So, for instance, beneficiaries might receive 5% of trust assets annually, with the trust continuing until all assets are exhausted or the trust’s value drops below a certain level. Some dynasty trusts entitle beneficiaries to larger principal withdrawals upon reaching certain ages or at certain milestones (e.g., college graduation, getting married). Alternatively, the declaration might give the trustee discretion to make additional distributions, or even distribute all assets, under specified circumstances.
The Asset Protection Benefits of Dynasty Trusts
Dynasty trusts are designed to keep assets within a family over multiple generations. If, for example, a grantor wants to provide for a son who is bad with money and also make sure that grandchildren are taken care of, a dynasty trust could distribute a steady income stream to the son for life without any risk that he will waste the bulk of the inheritance before the grandchildren come of age. Even more, assets held in a dynasty trust are provided asset protection benefits in Florida because they are held outside the reach of beneficiaries’ creditors until distributed. So, a bankruptcy court cannot levy trust assets to pay an insolvent beneficiary’s creditors, though distributions would likely be attached.
Along with preventing asset-squandering or attachment, a dynasty trust enables unified ownership of assets. Through multiple generations, the value of an estate can be diluted as each generation adds more heirs. Keeping the assets in one place facilitates more efficient asset-management by letting a single trustee manage the wealth for the trust, as opposed to numerous heirs managing smaller shares individually. By allowing for more investment flexibility, unified ownership creates the potential for greater returns.
Because the trust is irrevocable, assets transferred to a dynasty trust are removed from the grantor’s taxable estate, meaning that they may help avoid or reduce federal estate taxes. The gift tax may still apply if the transfer exceeds the exemption amount ($11.18 million as of 2018), but the trust avoids additional transfer tax liability for later generations. Dynasty trust assets will only be subject to estate, gift, or generation skipping (GST) tax for the initial transfer, avoiding tax liability for later generations.
How do Dynasty Trusts Decrease Transfer Taxes?
When a grantor with a qualifying estate transfers assets to a dynasty trust, he or she can also transfer some or all of the gift/estate tax and/or GST exemptions. To the extent the transferred assets are within the $11.18 million exemption, the assets are not subject to estate and GST taxes for the duration of the trust. Any excess is subject to federal transfer taxes when the trust is funded but not again when future descendants become beneficiaries. Even if the grantor’s great-great-grandchildren receive distributions from the trust, there will be no further transfer taxes on the trust assets as long as the trust is effective. With a large estate over several generations, this can result in dramatic tax savings compared to the repeated estate taxes otherwise assessed each time wealth descends to the next generation.
Just as importantly, growth on assets held in a dynasty trust is not subject to additional transfer taxes, regardless of the total value at the time of the grantor’s death. So, if a trust naming the grantor’s children as beneficiaries is funded with assets worth $10 million, and the grantor transfers the exemption when the trust is funded, the trust assets will not be subject to any transfer tax – even if the value has increased dramatically by the time of death. Conversely, if our would-be grantor elected to invest that same $10 million outside of the trust, and, upon his or her death twenty years later the investment is worth $25 million, the excess over the allowable exemption would get hit with the estate tax at rates as high as 40%.
The gift and estate tax exemptions are linked – meaning each taxpayer gets the $11.18 million exemption for life and death, and any use of the gift tax exemption reduces the estate tax exemption dollar-for-dollar. But there’s a key distinction between the two. The gift tax is “tax exclusive,” so funds used to pay the gift tax are not counted when calculating the tax due for the gift. But the estate tax is “tax inclusive.” Estate funds used to pay the tax count toward the estate’s value when determining the amount of the tax. As a consequence, an inter vivos transfer to a dynasty trust, even if greatly exceeding the gift tax exemption, results in lower taxes than the same transfer if it comes from the estate after death.
The ability to limit transfer taxes through multiple generations is a big part of a dynasty trust’s appeal. But it’s not the only part. Even if your estate won’t qualify for transfer taxes, a dynasty trust can help preserve wealth for future generations and ensure your assets continue to benefit your family well after you’re gone – consolidated for efficient management by a competent, dependable trustee. An attorney with expertise on dynasty trusts in Florida can help you decide if a dynasty trust should be part of your estate planning strategy.
Steve Gibbs, Esq.