As parents and students confront the many uncertainties surrounding college in the COVID-19 era—including in-person vs. online classes, safety considerations, and numerous other gray areas—the need for sound financial planning has never been more acute. Instead of making decisions on the fly based on shifting circumstances, many families are relying on counsel from their advisors to determine the best path forward.
For high-net-worth and ultra-high-net-worth families, the intricacies of paying for college may not seem quite as urgent as they do for the middle class or mass affluent, but they can be quite complex. Conversations with wealthy clients can involve not just how to pay and plan for education in a tax effective way, but also how they can set their children up for future educational success.
The most effective college financing plans often integrate multiple financial and estate planning techniques, but this year, in particular, Delaware Dynasty Trusts, which hold assets that benefit successive generations of descendants, should considered as part of the tool kit. A transfer into a Delaware Trust today can significantly reduce a future estate tax liability while still allowing for extensive flexibility. Here are four big reasons why advisors should be taking a close look at these vehicles as they discuss education with their high net worth clients:
The Limit is at an All-Time High
The amount each individual can gift without a federal gift tax consequence is at an all-time high of $11,580,000—for now. This limit is set to be halved on January 1, 2026, but given the huge strain on the federal fiscal purse strings caused by COVID-19, many believe that federal exemption amounts will be reduced even sooner, regardless of the 2020 election results.
This creates added incentive to use the current generous gift exemption amount by funding a Delaware Dynasty Trust now, while that high exemption amount is still available. It is generally advisable to fund the trust with cash or high basis assets to avoid the loss of a step-up in basis” at death, where the basis of assets in an individual’s estate is increased to its fair market value, potentially eliminating capital gains tax when those assets are sold by heirs. Sophisticated financial projections can illustrate the consequences of estate tax versus capital gains tax.
The Gift is Two-Fold
A Dynasty Trust can be structured as a grantor trust, resulting in the trust’s income being taxable to the trust creator during his or her lifetime. Although it does not have a gift tax consequence, the payment of income taxes by the creator is, in effect, an additional tax-free gift to the beneficiaries because, to the extent the creator is paying the taxes, the trust is relieved of that income tax burden.
This essentially allows the trust to grow tax-free, a highly attractive benefit. After the creator’s death, the trust will be treated as a separate taxpayer for income tax purposes. However, with careful structuring, it may be possible to avoid state taxation at the trust level as well by creating the trust in a jurisdiction with favorable laws, like Delaware.
It Helps the Estate Today and in the Future
A transfer of funds to a Dynasty Trust reduces the donor’s estate, not only by the amount of the funds transferred, but because the gifted funds are out of the donor’s estate, the future appreciation on those funds also escapes estate taxation.
While some jurisdictions limit how long a trust can last, certain jurisdictions will allow the trust to continue indefinitely. This is one of many important reasons we recommend establishing the trust in The Diamond State. Under Delaware law, there is generally no limit to a trust’s duration. Therefore, assets can usually continue in trust as a family legacy free of estate and gift taxes indefinitely.
It Allows for Flexibility
The terms of a Dynasty Trust can allow for a great deal of flexibility. For instance, trust funds can potentially be used to fund any part of education from pre-school to graduate school, or programs outside the traditional classroom setting, such as extracurricular activities or self-improvement programs.
The trust funds also need not be earmarked for educational purposes, so while they are available for that purpose, funds can also be used by the creator’s descendants for other purposes.
For high-net-worth and ultra-high-net-worth clients looking for greater flexibility in how they plan for and fund education, there has never been a more advantageous time to look at Dynasty Trusts. But with political change potentially on the horizon, there is no time to waste. The window to take advantage of this strategy is closing rapidly.
Sharon L. Klein is President, Family Wealth, Eastern Region for Wilmington Trust