With the generous Trump-era estate exemption limit set to expire in two years, affluent families high-net-worth clients (that is, those with $10 million or more, are kicking their estate planning into high gear. Families gave away over $180 billion in 2021, more than twice what they gave away in 2020 according to Internal Revenue Service statistics, and in 2022 and 2023, I suspect it will be substantially more. Because clients tend to procrastinate about difficult decisions like planning for their death, it could be an estate planning free-for-all in 2024 and 2025. Don’t let your clients wait until the last minute. The right planning takes time, and not all trusts are created equal.
Most HNW couples (and their trust designers) take the easy way out with a simple revocable trust. The thinking goes like this: “We want our kids to have access to the money in stages rather than all at once. So, we're going to pay one-third of the inheritance out when they’re 35, one-third when they're 40 and the remainder when they're 45.” Great. So, you’ve done all this planning to get the money out of your estate. But now it goes right back into the kids’ estates, meaning now it's their tax obligation. You’ve only kicked the estate tax can down the road by one generation.
But a dynasty trust keeps the family’s wealth out of the tax stream for as many generations as possible. That’s why I often recommend them for families who have children and at least $10 million in net worth. The kids can access the money to do just about anything, but because the client hasn’t technically given it to them, it’s never in their estate and it’s never subject to tax again. Thus, grandparents can leave wealth to great-grandchildren – even those who haven’t been born yet -- and not have to worry about federal estate taxes eating into the family’s wealth.
In a conventional trust, assets are typically left to living beneficiaries, and there’s an end point, often 21 years after the death of the last grandchild. At that point, the assets must be included in someone’s estate—that is, the offspring of the last grandchild named in the trust. But a dynasty trust can continue for many centuries (for example, 365 years in Nevada). This means the assets remain free from estate taxes essentially in perpetuity, which is a powerful impetus for many wealthy families.
Dynasty trusts also have strong creditor protection features. Unlike conventional trusts, dynasty trusts offer protection that spans multiple generations. When structured properly, a dynasty trust keeps the money in the family. If any heirs get divorced, ex-spouses can’t access the money. In fact, I like dynasty trusts better than pre-nups, because the trust existed long before the engagement, and the new bride or groom isn’t put in an awkward situation before the wedding. And in terms of creditor protection, if any heirs start a business that goes bankrupt or get into a car accident that causes a serious injury, their assets remain protected.
Real World Example
I recently worked with a couple worth $45 million to $50 million. They have four adult children, including one who’s still financially dependent on them. As a married couple, they each have a $12.92 million exemption, so they can get roughly $25.84 million out of their estate. With some tweaking and fine tuning, they might be able to get another $9 million out of their estate if they set up a conventional trust. But that still leaves another $10 million to $15 million subject to 40% tax at the federal level, and even more in their home state. And in two years, when the historically high exemption limits from the 2017 Tax Cuts & Jobs Act expire, the amount of their wealth exposed to estate taxes will likely double.
But, with a dynasty trust, the entire amount of their estate can be shielded from the estate tax for generations to come. And again, the assets are protected from creditors and ex-spouses essentially into perpetuity.
Factors to Consider
Dynasty trusts work best for estates in the $10 million to $20 million range and up – which includes over 1.5 million U.S. households according to the U.S. Federal Reserve. Some affluent families don’t want their kids to become trust fund babies, but it all comes down to education and training, family culture and a number of other factors. It's not the money that corrupts the kids; it’s the lack of family centric moral values.
So, why aren’t more HNW families using dynasty trusts? I’ve found it’s primarily due to lack of education among the affluent and their advisors. First, you have articles like this recent piece in the Wall Street Journal that implied dynasty trusts “skirt” estate taxes and are disallowed in most states. It’s true that many states don’t allow dynasty trusts, but if your client resides in a state that disallows them, they can set up nexus in a state where dynasty trusts are allowed. For example, you can have a Nevada trust company, which charges you a few thousand dollars a year to be the co-trustee of your client’s trust in Nevada.
The top tier states for dynasty trusts are Alaska, Delaware, Nevada and South Dakota because they allow dynasty trusts and don’t impose state income tax on trusts. Click here for more about state-by-state rules on perpetuities.
Some families you work with may not have enough wealth to warrant the complexity of a multigenerational trust. And unmarried couples or those who don’t have children, generally don’t need one.
Bottom line: It’s no harder to set up a dynasty trust than any other kind of trust. Sure, there’s some time and cost involved, but think of it as an investment not a cost. Paying taxes doesn't take any time or effort. It just costs a lot of money. Which would you prefer?
Just don’t wait until 2025 to get your client’s trust in order as it’s going to get awfully crowded heading into the “sunset.” And once your client’s dynasty trust is established, make sure you do a yearly review with them, just like getting an annual physical. What's changed? Did someone die? Did someone get married? Was a baby born? If possible, get all the adult children in your client’s family up to speed about the trust because kids often become co-trustees of their own trust.
Collaboration Required
Establishing a dynasty trust is a decision for a family’s wealth that’s going to last generations, so there needs to be collaboration among the financial advisor, the family’s attorney and family members to make sure the terms are reasonable and accomplish the goals of the grantors. That’s where you can bring significant value to your client and help their charitable contributions make a bigger impact.
Randy A. Fox, CFP, AEP is the founder of Two Hawks Consulting LLC. He is a nationally known wealth strategist, philanthropic estate planner, educator and speaker.