Dynasty Trusts: Preserving Wealth Through Generations

One of the best gifts you can give your family is financial security. However, if you have accrued significant assets, passing them on to your loved ones in your estate can be difficult without substantial tax penalties. That’s why dynasty trusts have been developed. 

These long-lasting trusts allow you to preserve and pass your assets onto your family with less risk of extraordinary tax bills. However, California laws significantly restrict how dynasty trusts can be established. 

Understanding Dynasty Trusts

A dynasty trust is an irrevocable trust containing property you want to pass on to your children, grandchildren, and other descendants. The purpose is to protect these assets from taxes, debt collectors, and even financially irresponsible beneficiaries. As long as the trust continues and contains funds, its beneficiaries will continue to benefit from them. As such, it is an excellent way to provide for your descendants long after you’re gone. 

The platonic ideal of a dynasty trust would last indefinitely, or into perpetuity. However, California has adopted the Uniform Statutory Rule Against Perpetuities. This rule states, “A nonvested property interest is invalid unless one of the following conditions is satisfied: 

  1. When the interest is created, it is certain to vest or terminate no later than 21 years after the death of an individual then alive.
  2. The interest either vests or terminates within 90 years after its creation.”

In other words, a trust is only valid in California if it has a termination date. That date may be either no more than 21 years after the death of the last beneficiary alive when it was created, or 90 years from the date it was formed. Despite this restriction, these entities still have benefits in California when used correctly. 

Benefits and Drawbacks of Dynasty Trusts for Estate Planning

While California dynasty trusts can’t last indefinitely, they can still last for decades when written properly. Some of the biggest benefits of adding these trusts to your estate plan include the ability to:

  • Avoid gift and estate taxes: Once assets are in an irrevocable dynasty trust, they are permanently removed from your estate. You only need to pay gift taxes once when you place them in the trust. If you expect the assets’ value to increase significantly, you may prevent a significant tax burden for your beneficiaries. 
  • Avoid the generation-skipping transfer tax (GSTT): The goal of a dynasty trust is to provide for all your descendants, grandchildren included. If you directly give or bequeath assets to someone more than 37 ½ years younger than yourself, you’ll face a 40% tax rate in accordance with the estate and gift tax threshold. However, assets within a dynasty trust are not subject to these taxes either. 
  • Maintain control over how the funds are used: When you set up your trust, you get to set the terms for how the assets are administered. This control allows you to prevent this from being misused or wasted if you so choose. 

However, these trusts do have drawbacks, especially under California’s perpetuity prohibition. Some of the biggest problems are:

  • Inability to alter the terms: Once you establish the trust, it is irrevocable. You cannot change its terms, beneficiaries, or trustees or remove assets. If you change your mind, there is no simple way to alter dynasty trusts after the fact.
  • Exposure to income taxes: Items within the trust are still subject to income taxes, so it is best used to hold assets that do not generate income. 
  • Conflict and tax penalties upon vesting: Once the trust vests, it may create capital gains tax and income tax obligations for the surviving beneficiaries. Additionally, there can be conflict among these beneficiaries if you were not specific about how to divide the vested assets. 

Designing Long-Term Trusts for Your Family

Dynasty trusts can be beneficial, but they must be drafted carefully to achieve their full potential to protect assets and support your loved ones. If you want to establish a dynasty trust or other long-term estate plan, reach out to The Dayton Law Firm P.C. Our San Jose estate planning attorneys can help you determine the best tools to achieve your goals for your assets. Schedule your consultation today to learn more.