For wealthy families trying to reduce possible estate taxes or protect assets for the long haul, irrevocable “dynasty” or “generation-skipping” trusts could help toward both goals.
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However, those trusts require not only a lot of intergenerational communication but also flexible drafting that leaves room for possible changes to state or federal taxes, according to Dawn Jinsky, a certified financial planner and certified public accountant who is the leader of estate and business transition planning at Southfield, Michigan-based registered investment advisory firm Plante Moran Wealth Management.
The current federal gift and estate tax exemption sits at $15 million, with inflation indexing in future years. This gives wealthy families an opening to move assets into those trusts now, generally shielding that wealth from the top 40% tax rate, should a future Congress ever revise the tax code. In addition, the trusts can safeguard assets from the possible ramifications of a divorce, lawsuit or a spendthrift heir’s wasteful spending habits.
“There could be a legislative urgency to do things in the future, depending on how that shifts,” Jinsky said. “Ultimately, I’m using that full $15 million exemption before political winds change and it comes back down.”
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Plante Moran Wealth Management
Managing the caveats and avoiding family conflict
Both generation-skipping trusts, often designed for grandchildren, and dynasty entities, which aim to pass down wealth in a tax-efficient manner across multiple generations, come with complicating factors.
In fact, dynasty trusts “remain one of the most powerful and most misunderstood structures in modern estate planning,” according to the description of “The Attorney’s Guide to Dynasty Trusts,” an e-book available through Leimberg Information Services, a training company for financial advisors and other professionals with high net worth clients.
“Used properly, they can preserve family wealth for multiple generations while reducing transfer tax exposure, protecting assets from creditors and creating long-term governance structures that survive well beyond the original grantor,” the guide said. “Used poorly, they create administrative complexity, unintended tax consequences and drafting problems that can last for decades.”
Many of those problems may stem from a lack of discussion within families about why they are creating the trusts, according to Jinsky. Even if planners must send the clients to an outside tax professional or attorney to set up the trusts, they can still help families avoid internal conflicts by encouraging often difficult conversations about the customers’ plans for passing down their wealth someday.
“Without clear transparency and communication around this issue, there can be some bad feelings about why Mom and Dad structured their estate this way,” Jinsky said. “The transparency and communication around it usually helps. It goes a long way.”
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Planning for the distant future
Either type of trust enables heirs to use the assets without them entering into the estate for purposes of the gift or generation-skipping taxes, but the trusts come with administrative cost and complexity and income duties, she said. So they may not be worth the price for families that aren’t close to topping the exemption level.
For dynasty trusts in particular, since tax professionals build them to last through multiple generations, the clients must remember that the “bank on Main Street that Grandpa used to walk down to has since been bought by three different banks,” Jinsky noted. And that could affect who is acting as the administrator or the trustee, along with the impact of any estate or inheritance taxes collected today in 17 states and the District of Columbia.
“Maybe it’s not your children dealing with these changes, but it’s your grandchildren trying to navigate state or estate tax changes,” Jinsky said. “From a drafting perspective, the more flexibility we can put in to allow the trustee or trust protector to modify the trust in that way, the better off you are.”
