A dynasty trust has significant tax benefits while ensuring that wealth is only transferred to the individuals you wish to benefit from it.
It’s a sad reality that estrangement and divorce can sour relationships with loved ones and impact family wealth. Taxes can also significantly impact intergenerational wealth transfers. Dynasty trusts, also known as dynasty irrevocable living trusts, address these issues.
There are no limits on how much an individual can place in a dynasty trust, but up to $11.4 million is tax-free, a figure which can double if each spouse entrusts their individual limit. The main benefit of a dynasty trust is that the corpus escapes the estate-tax regime generation after generation, instead of being taxed at each generational transfer. And, like other trusts, dynasty trusts also offer asset protection from divorcing spouses, creditors, and other potential threats to wealth.
The weakness of wills
Contrary to popular belief, a will is not cast-iron documentation of an individual’s wishes. Wills can be, and are, frequently challenged as they are subject to probate. This process can take years and drain significant wealth in the process. Furthermore, probate publicly reveals all debts, assets, and heirs involved in a disputed legacy since payment of the deceased’s creditors, obligations, and outstanding taxes must occur before the estate is distributed.
Many wills do see chosen beneficiaries receive their share of the wealth, but how long will it remain theirs? Failed relationships and split wealth can unravel a will’s ultimate goal. If assets are left to a child who goes on to divorce, for example, a great deal, if not most of them could fall into unintended hands or be lost to legal expenses.
The problem with per stirpes
Per stirpes is a legal term that describes a default process designed to distribute multi-generational wealth to a testator’s (the person making out the will) heirs if the direct heir passes before the writer of the will does and changes the documents. Typically, this means grandchildren will receive the assets if their parents die, followed by the grandparent passing. However, potential issues with per stirpes can cause problems for multi-generational wealth planning.
If an individual’s direct heirs pass away, any grandchildren will inherit per stirpes upon the death of the testator. In many instances, this exposes a very young person to sudden wealth. Such a windfall at an early age may not be used wisely and could be lost to ill-advised financial decisions.
Old policy language can impact multi-generational wealth transfers
Wills can be altered while their authors are still alive, just as dynasty trusts can (before they are funded). However, each must have a current beneficiary designation. These designations override the wishes of a will and can even overrule some forms of trust.
Divorce or estrangement may see one or more parties removed from a will or trust. Still, not everyone is diligent enough to review and modify their insurance policies and estate documents. For example, legacy documents may be altered to reflect an individual’s current wishes, but a life insurance policy might still name the wrong person as a beneficiary.
At the time of death, the insurance document will be favored. Every wealth transfer strategy should include a thorough review of all current beneficiary designations to defend against this possibility.
The many strengths of dynasty trusts
The public nature and length of probate, the loss of assets to unfavored parties through divorce, and the sudden inheritance of wealth by minors can all be avoided with a dynasty trust. These trusts do not involve the courts and thus avoid incurring a loss of wealth to legal fees or creditors.
Assets pass smoothly to the trustor’s designated blood relatives under specified conditions. Dynasty trusts are also exempt from gift and estate tax, transfer tax, and generation-skipping tax for as long as assets remain in the trust.
A dynasty trust can also specify provisions that address youthful inheritance and undue influence. For example, the trustor may set rules that the dynasty trust may only be accessed at certain times, for specific amounts, or upon key events such as medical expenses, education, or buying a home.
The appointment of a trustee may prevent undue influence. Even if a blood relative successfully inherits everything you intend, they could be vulnerable to bad financial advice from spouses, relatives, or outside parties. A trustee can serve as an impartial referee who prioritizes the inheritor’s well-being, the wishes of the deceased, and the continuation of family wealth. This may be an attorney, a financial services entity like a bank or wealth advisor, or even a trusted private individual who oversees the distribution of the trust’s assets.
For further advice on trusts and wealth management for generations to come, get in touch with our team at the link below.
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