The Case for Establishing a Dynasty Trust

The grantor funds the trust with assets intended to benefit future generations. Although the beneficiaries pay income tax on distributions received from the dynasty trust, they do not pay generation-skipping transfer taxes so long as the grantor used enough of their lifetime GSTT exemption to fully cover the assets gifted to the trust. Assets in the trust are allowed to stay invested with the potential to accumulate additional wealth for each successive generation.

To explore the benefits, let's consider two hypothetical cases of generational wealth transfer: One that does not use a dynasty trust and one that does. Consider the case of a wealthy grantor who decides to use her full lifetime estate, gift, and generation-skipping exclusions to transfer $15 million in assets to her child. (Those three lifetime exclusions are unified exemptions with the same pot of money covering all three: estate, gifts, and generation skipping transfers.) The transfer to her child will be free of estate and gift taxes—because it's within the exclusion—but subsequent transfers will each be subject to estate tax and potentially generation-skipping transfer taxes, if the grantor's child gifts to grandchildren, for example. The ongoing inflation adjustments to the lifetime tax exclusion will protect some of this potentially growing estate, but taxes will take a bite out of this wealth each time it changes hands.

Another grantor, however, decides to transfer $15 million to a dynasty trust in 2026. Her estate will not owe any transfer taxes on that money (although, again, her child and subsequent heirs will owe income tax on distributions received from the trust). As the assets of the trust pass from generation to generation, they are not included in the estates of trust beneficiaries. As shown below, those tax savings can add up meaningfully over time, adding $47 million to the estate by the time the fourth generation comes of age, in our hypothetical example.

Assets are held in the name of each generation's estate and are subject to estate taxes each time they pass to the next generation.

Assets are held in the dynasty trust and are protected from future estate taxes each time they pass to the next generation.*

A dynasty trust is a sophisticated legal vehicle that must be properly drafted to get the most benefit. Here are four decisions to consider before meeting with a qualified estate-planning attorney:

1. Where the trust is sitused: The state in which your trust is established (sitused) is critical for two reasons:

   a. Some states limit how long a trust can last, so you'll want to situs your trust in a state that allows trusts to exist in perpetuity—such as Alaska, Delaware, Illinois, Missouri, New Hampshire, Ohio, Rhode Island, and South Dakota—or for several hundred years, as is the case with Florida, Nevada, Tennessee, and Wyoming.

   b. Not all states have an income tax. For example, if you situs your trust in Nevada, which does not have an income tax, there will be no state tax levied on any income produced by the trust's assets. Further, if your beneficiaries happen to be Nevada residents, they will not have to pay state income taxes on their distributions.

   It's important to note that, generally, trust laws aren't dependent on where you (the grantor) live, but where the trustee lives. In fact, appointing a corporate trustee with a physical presence in a state with more advantageous trust laws, can allow you to utilize a different state's laws to better help accomplish your legacy goals.

2. Which assets you transfer to the trust: A dynasty trust can be funded with almost any type of asset or property, including cash, investments, real estate, business interests, and valuable personal property. Grantors looking to lower their taxable estate and slow their estate's growth often elect to transfer assets with high growth potential or that produce significant income. By contrast, those more concerned with reducing income tax for their heirs tend to fund their dynasty trusts with cash or tax-efficient assets.
3. When you fund the trust: Funding a dynasty trust can be done in a single lump-sum gift or spread out over time. If a grantor chooses the latter approach, they can use their annual gift exclusion (currently, in 2026, $19,000 per donor to an unlimited number of recipients) to give without reducing their lifetime gift exemption. Gifts above that annual gift exclusion to any individual begin to eat away at the unified exemption. For lump-sum gifts, the grantor must report them on their gift and generation-skipping tax return (Form 709) for the year in which the gifts were made. That form also tracks individual gifts above the annual gift tax exclusion, so that the IRS can track how much of a grantor's overall exclusion has been used.

4. How assets will be distributed: Most generational wealth is depleted by the third generation. To help extend the life of their legacy, a trust's grantor can set certain rules for how the trust funds may be used. For example, rather than giving beneficiaries full access to funds, grantors commonly limit distributions to funds used for the health, education, maintenance, and support of the beneficiaries.

   However, a grantor may add additional incentives, such as authorizing the trustee to make distributions each time a beneficiary is awarded a degree from an accredited institution for higher education. Or disallowing distributions if the beneficiary does not have full-time employment, with certain exceptions.

Given the complicated structure of a dynasty trust, it's best to choose a trustee with experience administering and managing them. Income-tax management, in particular, is important because taxes can eat into the overall performance of the assets. On top of managing and investing the trust assets in a tax-efficient manner—which may include tax-loss harvesting or selling tax-inefficient assets to purchase more tax-efficient ones—a trust company can make sense due to the long time period of the fiduciary obligation.