We hear from experienced estate planning attorney Elijah Keyes in this article, which takes an in-depth look at dynasty trusts. What benefits do they have to offer trustees, and what are the potential complications that should be taken into account?
Starting simply, what is a 'dynasty trust' and who is it meant to serve?
A dynasty trust is a type of irrevocable trust designed to provide long-term financial management, asset protection and wealth preservation for future generations in a family. It is created to serve the interests of an individual or family, aiming to maintain and transfer wealth to future generations while minimising loss to divorce, creditors and estate taxes.
The key feature of a dynasty trust is its duration, which can last for multiple generations. In California, the maximum term of a dynasty trust is often about 90-100 years after creation, but other US states have longer terms, sometimes in perpetuity.
The beneficiaries of a dynasty trust typically include the settlor’s (the creator’s) children, grandchildren and subsequent generations. By utilising a dynasty trust, the grantor can ensure that the assets within the trust remain protected from estate taxes, creditors and potential divorces or lawsuits that beneficiaries might face.
What distinguishes dynasty trusts from other forms of estate planning, and what are the benefits of using one?
Most estate planning is used to avoid probate courts. We use revocable trusts to avoid probate court proceedings to transfer assets after the death of a loved one. We also use general durable powers of attorney and advance health care directives to appoint representatives when a person loses capacity in order to avoid the requirements of a court-appointed agent call conservator or guardian.
However, dynasty trusts are used to protect future generations after the creator’s death, not the creator. It is used to protect future generations in three specific ways:
Protection in the Event of Divorce: More than 50% of marriages end in divorce. California has significantly higher divorce rates than the rest of the US. If assets are left directly to a child who later goes through a divorce, the spouse may receive half of the money and use it to purchase a brand-new car to drive away from the divorce court!
Any California divorce attorney will tell you that when individuals inherit money, it can easily become ‘commingled’ or mixed with their community property. This can occur if both spouses' names appear on the accounts, or even when assets are placed in a revocable trust that is in both names. It is extremely unromantic to prepare and have both spouses sign a pre- or post-nuptial agreement allowing your child to secure inherited assets.
The key feature of a dynasty trust is its duration, which can last for multiple generations.
If a child’s inheritance is left in this trust, it will be segregated and will likely survive a divorce.
In fact, giving assets to a dynasty trust might also give a child a viable excuse to not mix the trust asserts with a spouse. If mom and dad set it up in the dynasty trust, then it can remain that way. This can alleviate the pressure placed on a child by an emotionally immature spouse to intermingle or mix their assets after marriage.
Protection from Litigation: Everyone is susceptible to being sued – a car accident with claims exceeding insurance coverage, a slip-and-fall on your property, a failed business transaction, etc. When gifting assets directly to a child, they are titled in the child’s name. If the child loses a lawsuit, all of that money could be lost.Assets given in a dynasty trust enjoy a very high level of asset protection. To access assets in the dynasty trust, a plaintiff must first win the lawsuit and then file a separate court action against trust distributions. Legal fees and the trust's structure become real obstacles. The dynasty trust erects a significant barrier between the collection and the child’s inherited funds.
When designing a dynasty trust, we often limit the purposes for distribution to a beneficiary. We deviate from the common practice where a trustee is instructed to provide for a beneficiary’s health, education, maintenance and support. Certain California court cases have confirmed that payments for healthcare and maintenance are more prone to lawsuits, so we avoid them in certain circumstances.
Estate Tax Protection: The dynasty trust is designed to apply the generation-skipping transfer tax to assets passing into the trust. This tax exemption allows assets passing through the dynasty trust to be passed to a child’s children (the grantor’s grandchildren) without paying estate taxes at the child’s death.
For example, $2 million left to a child and invested well could be worth $16 million or even more when the child dies. Estate taxes would give a big chunk of it to the government.
Leaving that $2 million to a child in a dynasty trust instead likely prevents the $16 million that is in that trust from being subject to estate taxes when the child dies. In many situations it can pass in total to the grandchildren.
How do the laws governing dynasty trusts vary from state to state? What are the key regulations in your own jurisdiction?
Each state has different probate and trust laws. California’s laws do not allow asset protection trusts or dynasty trusts to be created to protect your own assets. Another person, like a parent, uncle, or even a family friend can create a dynasty trust for a child. But a child cannot create one for themselves.
Also, California allows a beneficiary to be the sole trustee of a dynasty trust at a certain age. Many other states require a co-trustee because of certain trust laws and practices.
The dynasty trust is designed to apply the generation-skipping transfer tax to assets passing into the trust.
The laws governing marital property are also different in many states. Most of the US follows a separate property standard, where each spouse owns his or her own earnings. California and six or seven other states follow a different theory – absent an agreement to the contrary, a spouse’s earnings are shared with the ‘community’, meaning owned 50% by the other spouse. A dynasty trust will provide the same protection against loss in a divorce in every state but provide more powerful protections in the community property states, as the laws tend to favour sharing assets between spouses.
Additionally, the laws regarding executing a judgment against a dynasty trust are different in each state. California tends to be more permissive towards collecting assets from a trust. Certain other states allow many trusts to resist most types of creditor intrusions.
What is the process involved in setting up a dynasty trust?
A dynasty trust is created by a contract signed by the settlor, just like any other trust document. The settlor must have a clear understanding of the nature of the trust and the reasonable consequences to have sufficient mental capacity to sign.
A dynasty trust is normally created in one of two situations:
First, when clients are creating an estate plan to control their assets and decisions at death, a dynasty trust can be created to receive gifts from parents. The trust largely stays dormant until funded with assets from the parents’ ownership, family trust, or even insurance. The dynasty trust can also be used to receive gifts from other family members. A grandparent or aunt who wants to give to a child can instead give to a dynasty trust created by the parents. Centralising the control minimises the expense and complication of future administration.
The other situation occurs when gifts will be made to a child now. This often occurs in conjunction when planning to transfer family wealth or a family business, or even when planning to avoid estate taxes. The dynasty trust is used as a gift recipient to make final gifts to the trust but prevent a loss of control. Often the child is not a trustee until reaching a certain age, preventing the child from making irresponsible or rash decisions. The dynasty trust trustee maintains the assets and directs that they be used for the child’s benefit without threatening the family’s wealth or business plan.
Are there any notable legal pitfalls relating to dynasty trusts? How can these best be prepared for and overcome?
The most significant pitfall is in a child or other beneficiary understanding the purpose and benefits of the dynasty trust. Children need to understand the trust’s benefits and proper operation so they do not accidentally defund the trust, effectively voiding all the protections.
Significant effort should be made to make longstanding documents like dynasty trusts effective by influencing the behavior of children. Some options include requiring the trustee to hire skilled attorneys and CPAs as advisors, including a professional co-trustee to serve alongside the child, or even requiring permission to withdraw assets from a third party.
How can the insight of an experienced estate planning attorney prove beneficial in the establishment or managing of a dynasty trust?
Dynasty trusts are designed for multigenerational tax avoidance by restricting direct ownership by a child. But this ownership structure has significant side-effects that make them effective and useful in many more situations. It is important for an estate planning attorney to intimately understand how a dynasty trust works and the key details and exceptions so they can be safely applied in as many situations as possible.
One example – a child with a severe drug habit should not receive direct gifts. A dynasty trust can be created with an independent trustee who will manage the trust assets for the beneficiary. This does not violate any rules of the dynasty trust, but it is used for an ‘off-brand’ purpose, simply because of the nature of the trust characteristics.
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What guidance would you offer to a new client on selecting the right trustee?
At the core, each trustee should be a trustworthy and intelligent adult. A trustee does not need to be a financial guru. Rather, the trustee should be a smart and reliable person who is willing to hire the right people to help navigate the world of trusts.
The trustee should be willing to use an estate planning attorney and tax preparer to help with the trust administration. The trustee may also need to consult with asset specialists, like a financial planner to help with investments or a realtor if real estate needs to be sold.
When should a client choose co-trustees?
Naming co-trustees can also be beneficial but should be carefully considered. If your chosen co-trustees fight every time they get together, they will probably continue to fight as co-trustees. In my experience, a client’s death is not likely to improve relationships.
Co-trustees can be very useful in certain situations. Naming different co-trustees can allow each person to lend their skills. co-trustees can also be useful to minimise conflict and provide perspective. Perhaps an older and wiser family member would be well suited to serve as a co-trustee with a younger and less experienced trustee.
What if the trustee lives far away?
Distance should be a factor in choosing a trustee, but there are also other issues to consider.
In the future, the trustee may need to visit or sell specific property, arrange for the transfer of personal items, or even visit specific banks to transition accounts. These tasks can be time-consuming and labour-intensive. They tend to be easier for a trustee who lives nearby or who can travel and stay for a week or more to manage these tasks.
In the past, living far away made accessing trust funds and paying bills very difficult. However, with increased accessibility to financial arrangements online, daily financial management can be done at a distance.
What if the client has no potential trustees?
If a client has no family or friends to name as trustee, consider a licensed professional trustee (also called a private fiduciary) or a bank to serve as trustee. They can generally be relied upon to make professional and responsible decisions. However, there are other factors to consider.
Professional trustees and banks do not work for free. In some cases, trustee fees may make their effort impractical.
Professionals are likely to take great care in administering the trust, perhaps taking steps a layman would consider unnecessary. This can be frustrating to beneficiaries who have little patience for accounting procedures or financial record keeping practices.
Professionals may hesitate to serve as co-trustee with a family member or layman. Many professionals report that serving as co-trustee with a less experienced trustee tends to raise trust expenses a great deal and may expose the professional to potential liability.
About Elijah Keyes
Please tell us about your journey into law. What was it that caused you to gravitate towards estate planning?
In law school I was encouraged to learn about different legal fields. I had six different internships with judges, tax litigators, a real estate company and even an art business firm. I had informational interviews with more than 40 practicing attorneys trying to understand what type of law and practice appealed to me. I interviewed real estate litigators, SEC compliance specialists, employment attorneys and personal injury lawyers.
For some reason, I gravitated to estate planning and tax work. It is complicated, difficult and often deals with interpersonal relationships. I love to teach and enjoy learning about and navigating family interpersonal relationships. Every day in my practice I educate consumers about different types of planning tools and how to improve their family relationships into the future. I find it incredibly rewarding.
Of your career achievements to date, is there one in particular that you feel most proud of having accomplished?
When starting my own firm, I felt like I was operating blind. I am a good attorney, but needed to learn how to run a business. I joined a national-level peer group with other estate planning law firms across the country. I travel each quarter to another law firm to learn from my peers and how to move my business forward. I could have figured out all the advancements my firm needed over time, but since joining this group they helped us move forward a lot faster. I am most proud of the team, systems and procedures we have built as quickly as we did.
Can you share anything about your plans for career development in the remainder of 2023?
We have several firm-wide plans. We recently moved into new office space to expand our footprint for growth. We have a beautiful office, courtesy of my wife’s skill in design. Our next step is to move to a new client relationship management system that will provide more automation and follow-ups in our client intake processes. Once the relationship management system is in service and has been thoroughly tested, we plan to start a client care program to stay more connected with our clients and their families in the future. This last goal is a far stretch for the year, but hopefully we will be able to start on it soon.
Elijah Keyes, Founder
500 E. Calaveras Blvd, Ste 333, Milpitas, CA 95035, USA
Tel: +1 408-766-7668
Elijah Keyes is a Certified Specialist in Estate Planning, Trust and Probate Law with more than 10 years’ worth of experience in estate planning and trust work. His work serving clients in the San Francisco Bay Area has earned him a number of professional accolades, being rated Superb (10/10) by Avvo and recognized as a Rising Star in Estate Planning (2017-2019) and Superlawyer in Estate Planning (2021-2023) by Superlawyers.
Keyes Law Group is a Milpitas-based law firm specialising in estate planning. The firm’s expertise covers a broad range of estate planning needs, including wealth planning and family transfers, dynasty trusts, trust administration, conservatorships, probate and elder law.
