According to an analysis by the Wharton School at the University of Pennsylvania, the average American inherits about $1,500 from their grandparents. Meanwhile, the ultra-wealthy can inherit millions of dollars to their grandchildren.
And thanks to Trump-era loosening of restrictions on generation-skipping trusts and tax cuts, the wealthy are leaving their wealth to distant heirs and avoiding paying hefty wealth transfer taxes.
Some of America's wealthiest families, including the Pritzker family, which owns Hyatt Hotels, the Wrigley family, the famous chewing gum financier, and the Bezos family, use intergenerational trusts to preserve their wealth. Dave McCormick, the former CEO of Bridgewater and a candidate for the U.S. Senate, has $2.25 million stashed in this type of trust, according to financial disclosures that show he is worth at least $123 million. That's what it means. So-called dynasty trusts allow a wealthy taxpayer to support up to 40 generations, and he is only subject to tax once.
Withers Bergman partner Sandy Christopher said dynasty trusts are growing in popularity as intergenerational transfer tax exemptions proliferate. The tax, known as GST, aims to prevent families from avoiding inheritance tax by gifting to grandchildren or relatives who are at least two generations younger than their children.
In 1986, the exemption amount was $1 million. Thanks to tax cuts made in 2017, this now equates to a federal estate and gift tax exemption of $12.92 million per individual and $25.84 million per married couple.
“The higher the exemption amount, the more it makes sense to create an estate that can last as long as possible,” Christopher told Insider. “The intergenerational tax exemption is very powerful for people making large gifts, establishing trusts, and building asset structures.”
The tax-free allowance will be cut in half at the end of 2025. Some wealthy families are holding off on creating dynasty trusts in hopes that further legislation will extend tax breaks, but that depends on the composition of Congress, said tax strategists at BNY Mellon Wealth Management. . Jere Doyle told Insider. Clients may rush to establish a dynasty trust before the exemption ends if they believe this is unlikely.
This is how a dynasty trust works.
A dynastic trust refers to the duration of a trust rather than a specific type of trust, but here's how it works in general:
Historically, trusts have lasted only 21 years after the death of a beneficiary who was alive at the time the trust was established. This rule against permanence dates back to 17th century England.
But over the past 40 years, more than half of U.S. states have either abolished this common law or significantly extended trust limits, allowing dynasty trusts to last as long as 1,000 years in states like Florida and Wyoming. I made it. In Delaware, trusts can last indefinitely, but there are certain limitations, such as the length of time that real estate is held within the trust.
The length of the trust is predetermined at the time of creation. Because dynasty trusts last for a long time, a corporate trustee is usually appointed, such as a bank or financial institution such as JP Morgan or Northern Trust.
GST is applied to the trust value at inception and a flat rate of 40% tax is applied to the exempted amount. There are few restrictions on funding a dynasty trust, but it is best to use income-producing assets that are expected to increase in value, such as family businesses.
Although the heirs do not own the assets outright, they are entitled to receive income from the trust, which is subject to income tax but not GST. In the case of real estate, heirs own real estate for life, so they do not own the property, but they have the right to live in the property and receive its benefits until their death.
Even if the trust lasts for centuries and its assets appreciate rapidly, the generation-skipping tax is only paid once. Any remaining assets will be passed to the final heirs and included in the taxable estate.
Tax savings from trusts designed to last decades or centuries are difficult to predict because tax laws are likely to change. However, Northern Trust states that if you bequeath $12.92 million and your family pays transfer taxes on each generation over 75 years, assuming an after-tax rate of return of 5%, your estate will be worth $108.40. It is estimated that the amount will rise to $10,000. Meanwhile, using a Delaware dynasty trust to avoid transfer taxes would increase his assets by nearly $400 million to $501.7 million.
Tax savings are not the only benefit
Most of Christopher's clients are not interested in preserving their wealth forever.
“When you actually talk to people, they don't really think about this in terms of that era,” Christopher said. “They have short-term or near-term concerns about their families.”
They are typically drawn to dynasty trusts to keep the business within the family and protect assets from creditors. Thanks to an 1875 Supreme Court case, life estates are protected from creditors if the trust has a spendthrift clause. Dynasty trust assets are also protected in the event of divorce.
Even for a longtime lawyer like Doyle, the idea of a trust lasting 40 generations can be daunting.
“I just can't imagine something lasting 1,000 years,” he told Insider.
Mr Doyle believes 90 to 100 years is a long enough time for a trust and advises clients against creating trusts that effectively last forever.
“It may be a good thing from a tax-saving perspective, but you also have to think about it from a practical perspective: Who are your grandchildren going to be? Who are your great-grandchildren going to be?” he said. “That can add up to a lot of money, and these people will never have any incentive to work, earn anything for themselves, or give back to society.”
Editor's note: This article was originally published in May 2023 and updated in February 2024 to add details about Dave McCormick's Dynasty Trust.
