Dynasty trusts don’t make much sense for most people.  But for those who qualify for federal estate taxes, dynasty trusts offer a means of reducing their taxable estate.

Whenever an asset is gifted to someone during life or at death, the grantor’s unified credit (currently $11.2 Million per individual and $22.4 Million per married couple) is reduced by the value of the asset.  This also occurs whenever a trust distributes an asset to a beneficiary—the gift is completed at that time, and the grantor’s unified credit decreases.  But if the trust holds onto that asset, only distributing income and not the principal, then the taxable liquidation event never occurs, and the grantor’s unified credit is never reduced by the value of the assets held in trust.

Dynasty Trusts are trusts with perpetual existence.  Many states are prevented from offering dynasty trusts due to their existing Rule Against Perpetuities, which limits the time period a deceased person may retain control over his or her assets after death.  In 1983 South Dakota became the first state to abolish its Rule Against Perpetuities, which opened the door for grantors to retain perpetual control over assets by keeping them held in trust forever.  In states with an existing Rule Against Perpetuities, these types of trusts would either be invalid from the start, or they would expire after the applicable period lapsed, forcing the trustee to distribute the assets held in the trust.  This distribution would be a taxable liquidation event.  In South Dakota, there is no time limit, so a trustee of a dynasty trust will never be forced to distribute assets to a beneficiary due to time expiration.

Dynasty Trusts make little sense for most people as time goes by because the income from the trust is spread across an ever-increasing number of beneficiaries.  Furthermore, most people shouldn’t be concerned about federal estate taxes given its high threshold (only 1 out of every 1,000 estates qualify for federal estate taxes).  But for those few who do qualify, a dynasty trust can be an effective tool for giving trust income to multiple generations while avoiding federal estate tax liability.  Grantors can provide a gift that keeps on giving without ever paying federal estate taxes on it.

The combination of the creditor protection provided for beneficiaries of such trusts, the asset protection provided for the grantors of such trusts, and the flexibility to decant these trusts, make South Dakota’s dynasty trust statute the most comprehensive and highest ranked in the country.[1]  Other states that offer dynasty trusts have either a time limit, decreased creditor protection, weaker asset protection, or less flexibility to distribute trust assets into a trust with more favorable terms.

If you are considering using a dynasty trust as part of your comprehensive estate plan, talk to our Sioux Falls estate planning attorneys to determine whether it’s a good fit for your long-term goals.

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[1] See Steve Oshins’ Sixth Annual Dynasty Trust State Rankings Chart (2018), https://docs.wixstatic.com/ugd/b211fb_5ba497da4c374872be424209eaf7ca7b.pdf.

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