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By Eric Rosenberg, WCI Contributor

If you’ve built up significant wealth over your medical career (or were lucky enough to inherit a sizable net worth from your family), you’ve likely considered the tax implications of what happens to your assets when you eventually pass them on to your children. A dynasty trust could be a good option for you.

Dynasty trusts are a type of irrevocable trust where you pass on wealth to your grandchildren or great-grandchildren without paying estate taxes multiple times. In other words, you're not letting the government get a cut of your estate for every passing generation. Sometimes called multi-generational trusts, these unique estate-planning tools can provide significant tax benefits when used correctly. Keep reading to learn about dynasty trust tax benefits and how they may benefit your heirs.

What Is a Dynasty Trust?

A dynasty trust is a multi-generational trust where your assets skip a generation. A dynasty trust could be a good option if you want to leave funds to your grandchildren or any future generation beyond your grandchildren.

Dynasty trusts can even be built to distribute assets to the children of your children (or their children) upon your eventual passing. While it’s no fun to think about dying, planning ahead can make your family’s life much easier when managing future wealth distributions. Most trusts offer simplicity and added privacy for your family by helping avoid probate when dealing with generational wealth transfer. But a dynasty trust could be an even better option if you want to save on estate taxes.

Note that we’re focused on federal estate taxes here. Some states require additional estate or inheritance taxes.

More information here:

Will vs. Trust: Which Do You Need?

History of the Dynasty Trust

In 1976, the US government put a stop to having to pay an estate tax for every generation. The philosophical reasons behind estate/gift/transfer taxes are interesting to discuss, but the fact remains that the law is the law, so you might as well understand it. You can either rejoice about it or complain about it later, depending on your political leanings.

At any rate, the government also has had a little-known (and seldom-applied) tax called the Generation-Skipping Transfer Tax since the mid-1970s. This basically ensures that estate taxes are at least paid every other generation. Before this, wealthy families could simply gift money and assets to their grandkids or great-grandkids, while skipping their own children, and not have to pay any federal estate taxes. With the passage of the Generation-Skipping Transfer Tax, a flat 40% tax had to be paid when property or other assets were transferred to a beneficiary who was at least 37 1/2 years younger than the donor.

Just as there is a $12.92 million exemption for the estate tax in 2023—a figure that increases to $13.61 million for 2024—there is also a separate $13.61 million exemption for the Generation-Skipping Transfer Tax.

Dynasty Trust Tax Benefits

When you pass on wealth to your children, they can inherit up to $13.61 million from each parent, or $27.22 million total, tax-free. Those are the 2024 exemption rates, which change annually. Any inheritance beyond that total is subject to up to a 40% inheritance tax.

That 40% tax can be painful if you're an ultra-high-net-worth household. But what happens if you pass on enough wealth to your children that your grandchildren must also pay the 40% tax? And again, their children could be subject to the 40% tax? That’s where dynasty trusts come in.

Using a dynasty trust, you can skip your children and pass on wealth directly to your grandchildren or great-grandchildren. By doing so, you skip your children’s inheritance for a portion of your estate and the taxes they may have to pay. If you leave a portion of your assets to your great-grandchildren, two generations can skip paying the 40% tax on inheritance above the estate tax exemption threshold.

Depending on the size of your estate, a dynasty trust could lead to millions of dollars in savings for your family. That’s a huge financial benefit. Here’s an example of how dynasty trusts work to help you better understand how it could work for you and your family.

Dynasty Trust Example

Here’s a dynasty trust example to show how the tax benefits could work. Suppose you’re a successful surgeon/entrepreneur with a spouse and a household net worth of $200 million. If you were to pass on that $200 million to your only child when you die, anything beyond $27.22 million is taxable at a 40% rate (we rounded here to simplify). That means your child would pay $69.7 million in taxes. Ouch!

If your child has three children, you could set up a $100 million dynasty trust to skip your child and list your grandchildren as beneficiaries. Upon your death, they would each receive $33 million.

While your grandchildren would have to pay estate taxes, the $100 million you passed onto your grandchildren is only taxed once. The estate would be taxed twice if you gifted your children the entire $200 million, and they gifted most of the remainder to your grandchildren. A dynasty trust saves 40% tax on the amount that skips your children.

Dynasty trusts can be complicated, so most households should consult an expert estate planning attorney or tax professional to ensure everything is set up correctly.

More information here:

Financial Advice for High-Income Doctors

Dynasty Trust Pros and Cons

Pros

• One or more generations can skip paying estate taxes
• More control over each generation’s inheritance
• Avoid probate for assets passed on through a trust

Cons

• Trust assets are locked into the trust once funded
• Challenging to adjust this type of trust once it’s created
• Your children can’t access trust assets

More information here:

The Importance of Revocable Living Trusts

Dynasty Trusts FAQ

Which States Allow Dynasty Trusts?

These states currently allow dynasty trusts: Alaska, Delaware, District of Columbia, Hawaii, Idaho, Illinois, Kentucky, Maine, Maryland, Michigan, Missouri, Nebraska, New Hampshire, New Jersey, North Carolina, Ohio, Pennsylvania, Rhode Island, South Dakota, Virginia, and Wisconsin.

Is a Dynasty Trust Revocable or Irrevocable?

Dynasty trusts are irrevocable trusts. You cannot withdraw funds once they’re placed into the dynasty trust.

Can a Spouse Get Money from a Dynasty Trust?

A dynasty trust is best for grandchildren or great-grandchildren. A spouse typically shares assets and isn’t subject to estate taxes.

Do Doctors Need a Dynasty Trust?

Most physicians will never have a need for this type of trust since the estate tax exemption is so high, but a few might. Remember, though, that if the estate tax and generation-skipping tax exemptions are cut in half (that could happen in 2026), this could very well become important to many doctors.

Final Word on Dynasty Trusts

For households with tens of millions in assets, dynasty trusts can lead to millions of dollars in tax savings along with the typical benefits of a trust. They’re a bit rigid and difficult to alter, but if you set up a dynasty trust with the right planning, they’re a major gift to your grandchildren and future generations.

Have more questions about estate planning or protecting your assets? Hire a WCI-vetted professional to help you sort it out.

Have you thought about using a dynasty trust? Do you already have one? What do you like and/or dislike about them? Comment below!

[This updated post was originally published in 2011.]

The post Dynasty Trusts: A Multi-Generational Estate Planning Tool appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.

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By: The White Coat Investor
Title: Dynasty Trusts: A Multi-Generational Estate Planning Tool
Sourced From: www.whitecoatinvestor.com/dynasty-trusts/
Published Date: Sat, 25 Nov 2023 07:30:23 +0000

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