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Dynasty Planning and Dynasty Trusts
You can utilize your Generation Skipping Transfer (GST) Tax exemption to plan for several generations and build enormous wealth. This type of planning is known as dynasty planning. One of the reasons Congress enacted the GST Tax is to curb the wealth-building effects of dynasty planning. The concept of dynasty planning is to pass the maximum amount of wealth you can to your grandchildren (and subsequent generations) in a dynasty trust without subjecting the transfer to the GST Tax. In so doing, you can exempt the trust property from future GST and Estate taxation.
Allocating your maximum GST Tax exemption to the dynasty trust for your grandchildren (and subsequent generations) will cause the trust to be exempt from GST Tax. Since wealth that is not subject to death tax has the potential to grow much faster than wealth that is taxed, the property transferred to a dynasty trust may accumulate and grow more rapidly than wealth transferred outright.
An Example of a Dynasty Trust
For example, assume you have $1 Million and that you leave it to your child. For ease of illustration, assume a $1 Million estate tax exemption, a $1 Million GST Tax exemption and a 50% estate and GST Tax rate. At your death, you can leave the full $1 Million estate tax free to your child. Assuming your child is able to double her inheritance to $2 Million over her lifetime, at her death, there would be an estate tax on $1 Million, so that your child’s estate would pay $500,000 in estate tax. This would leave an inheritance of $1 .5 Million to you grandchild. Assuming your grandchild is able to double her inheritance over her lifetime, she would have an estate of $3 Million at her death. After estate taxes, she would be able to leave a $2 Million inheritance to your great- grandchild.
In the alternative, what if you had funded a dynasty trust with your $1 million and allocated your estate and GST Tax exemptions to make the trust exempt from estate and GST Tax? Assume that the trust value doubles at every generational level just like the above Scenario. Upon your child’s death there would be $2 million in the trust with no death tax due. Upon your grandchild’s death there would be $4 million in the trust for the benefit of your great-grandchild, with no death tax due.
Notice the amount left to the great-grandchild under the first scenario was $2 million and under the second scenario was $4 million.
Once property is exempted from the GST Tax, all future appreciation and growth potential of the underlying assets in the trust also remains exempt from GST Tax.
As you can see, Dynasty Planning can account for growth in wealth over several generations. And, it is logical to most families that any benefits given to their children through their estate plan should be extended to their grandchildren and beyond.