When it comes to preserving your hard-earned wealth and passing it on to your heirs, EsqWealth recommends proactive estate planning. It is not just a wise choice; it’s become an urgent necessity due to recent and expected changes in tax laws. Without proper planning, you could inadvertently leave your loved ones with an enormous tax liability, potentially forcing them to liquidate assets just to meet their tax obligations.
The Tax Cuts and Jobs Act (TCJA) of 2017 brought a significant change to estate and gift tax exemptions. The lifetime gift tax exemption for individuals of $5.6 million and for couples of $11.18 million was doubled, setting them at $11.18 million for individuals and $22.36 million for couples. These figures were indexed for inflation after 2018. Fast forward to 2023, and the exemption has further increased to $12.92 million per person and $25.84 million for married couples.
However, in 2026, these exemptions will be halved and adjusted for inflation, potentially impacting your estate planning strategies. As a result, high-net-worth families are confronting a critical need for comprehensive estate planning. Many affluent couples gravitate toward the simplicity of a revocable living trust in their estate planning endeavors. Their rationale is straightforward: they wish to provide their children with controlled access to their inheritance over time. However, this approach, while effective in reducing the overall size of the estate, merely postpones the estate tax liability by one generation for large estates.
Benefits of Dynasty Trusts for Your Legacy:
- Tax Efficiency: Dynasty trusts are an exceptional tool to minimize estate taxes. By placing your assets within a dynasty trust, you can shield them from estate tax liabilities for generations, allowing your wealth to continue growing and compounding over time.
- Asset Protection: Dynasty trusts offer robust creditor protection features. In situations such as divorce, the assets within the trust are shielded from ex-spouses. In fact, some prefer dynasty trusts over prenuptial agreements because these trusts existed long before any engagements, preventing any awkward pre-wedding situations. Furthermore, dynasty trusts safeguard assets in case of bankruptcy or severe injury, ensuring the preservation of your wealth.
- Generational Wealth: A dynasty trust enables you to pass on not only your financial assets but also your core values and principles. For example, you can establish provisions for philanthropic goals and educational support, instilling a sense of responsibility and stewardship within your family.
- Flexibility: Despite their irrevocable nature, dynasty trusts offer flexibility. Trustees can make decisions based on the evolving needs and circumstances of your descendants, ensuring that the trust remains adaptable to changing family dynamics and goals.
A Hypothetical Scenario
Imagine a hypothetical couple with a net worth of $75 million and four adult children. In 2023, each spouse has an exemption of $12.92 million, enabling them to shield approximately $25.84 million from their estate. With strategic planning, they might extract an additional $10 million through a conventional trust. However, this would leave around $40 million exposed to federal estate taxes, and even more at the state level. Current federal estate taxes max out at 40% for taxable amounts greater than $1 million. Thus, under this hypothetical, the four children could be faced with needing to come up with $16 million to pay Uncle Sam. If the assets in the estate are not liquid, that type of tax burden could create a very difficult situation. With the expiration of the historically high exemption limits from the 2017 Tax Cuts & Jobs Act approaching, their exposure to estate taxes could increase significantly in just two years.
Enter the dynasty trust: a solution that can safeguard their entire estate from estate taxes for generations to come. Additionally, these assets remain protected from creditors and ex-spouses indefinitely.
Additional Considerations for Dynasty Trusts
Dynasty trusts are generally most effective for estates ranging from $10 million to $20 million and beyond, which includes over 1.5 million U.S. households, according to the U.S. Federal Reserve. Concerns about creating trust fund dependents are valid, but it’s important to recognize that this hinges on education, family culture, and values, rather than solely on the amount of wealth. Money itself doesn’t corrupt; the absence of strong family-centric values can be the real issue.
So, why aren’t more high-net-worth families embracing dynasty trusts? One obstacle appears to be a lack of education among the affluent and their advisors. Misconceptions often arise, such as the belief that dynasty trusts wrongfully evade estate taxes and are prohibited in most states. While many states do not permit dynasty trusts, residents can establish a nexus in a state where they are allowed. For instance, a Nevada trust company can act as the co-trustee of a client’s trust, ensuring compliance with Nevada’s regulations.
Top-tier states for dynasty trusts include Alaska, Delaware, Nevada, and South Dakota, as they permit dynasty trusts and do not impose state income taxes on them.
Establishing a dynasty trust is no more complex than setting up any other type of trust. While there may be some initial time and cost involved, it is truly an investment in securing your family’s wealth for generations. Rather than paying hefty taxes, consider the enduring benefits of a dynasty trust.
It is best not to delay until 2025 to take action, as there is expected to be a rush to secure trusts as exemption limits expire. Once established, conducting annual reviews is crucial, similar to an annual physical examination. Keep all family members informed about the trust, as adult children often become co-trustees of their own trusts.
At EsqWealth, we encourage clients to have a comprehensive financial plan, which includes much more than just how your investable assets are invested. It considers tax planning, retirement planning, and estate planning. Depending on your net worth and goals, one consideration for your estate plan may be implementing a dynasty trust. Setting up a dynasty trust is a decision that will impact your family’s wealth for generations to come. Collaboration among financial advisors, family attorneys, and family members is key to ensuring that the trust’s terms align with your goals and values, making a lasting impact on your charitable contributions.