What Is a Dynastic Trust and How Does It Work?

A dynastic trust is a long-term, irrevocable financial tool designed to transfer wealth across multiple generations. Its primary characteristic is its duration; if structured correctly, it can last for many decades, or even indefinitely, depending on state law. The purpose is to preserve a family’s assets, allowing them to grow and be distributed to children, grandchildren, and subsequent descendants.

Once the person creating the trust, known as the grantor, transfers assets into it, they relinquish control. The trust becomes the legal owner of the property. The grantor sets the rules for how the trust is managed and how funds are distributed to beneficiaries, but these terms are permanent once the trust is funded.

Core Tax Implications

A central feature of a dynastic trust is its ability to minimize the federal Generation-Skipping Transfer (GST) tax. This 40% tax is imposed on wealth transfers to individuals two or more generations younger than the donor, such as a grandchild. The tax applies to direct gifts and trust distributions to these “skip persons,” a category defined by the IRS to include family members more than one generation removed.

The effectiveness of a dynastic trust hinges on the GST tax exemption, which is $13.99 million for 2025. A grantor can transfer assets up to this amount into a trust and allocate their exemption to the transfer. This makes the trust fully exempt from the GST tax for its entire duration.

This high exemption amount is temporary. The current levels were established by the Tax Cuts and Jobs Act and are scheduled to sunset at the end of 2025. On January 1, 2026, the exemption will revert to its prior, lower level, which is anticipated to be about half of the current amount.

This means all assets inside the trust, along with any future growth, are sheltered from further estate and GST taxes. For example, if a grantor funds a trust with $13 million and allocates their exemption, and those assets grow to $30 million, the full amount can be distributed to grandchildren without triggering the 40% GST tax. This allows for the compounding of wealth over many decades, undiminished by transfer taxation.

The GST tax exemption is not “portable” between spouses in the way the estate tax exemption can be. Each person must use their own exemption, making careful planning important for married couples.

State Law Considerations

The longevity of a dynastic trust is directly governed by a state-level legal principle known as the Rule Against Perpetuities (RAP). Historically, the common law RAP was designed to prevent property from being locked away in trusts indefinitely. The rule required that an interest in a trust must vest no later than 21 years after the death of the last identifiable individual alive when the trust was created.

This legal landscape has changed dramatically, as many state legislatures have significantly altered or completely abolished their versions of the RAP. This shift has been a primary driver in the rise of modern dynastic trusts, as it allows for the creation of trusts that can last for hundreds of years or, in some jurisdictions, forever. States have taken different approaches; for instance, some now permit trusts to last for specific long terms, such as 360 or 500 years, while others have no time limit at all.

This variation in state law has led to the practice of “jurisdiction shopping,” where individuals establish their trusts in states with the most favorable laws, regardless of where they live. To do this, it is necessary to appoint a trustee, such as a bank or trust company, that is located and operates within that chosen state. Selecting a jurisdiction that has eliminated the RAP is a key step for anyone wishing to create a true “perpetual” trust.

Information Required for Creation

Before a dynastic trust can be drafted, the grantor must make several foundational decisions. The first is to select a trustee, the individual or institution responsible for managing the trust’s assets and following its instructions. It is also necessary to name successor trustees. A corporate trustee, like a bank, is often chosen for its longevity and professional management.

Next, the grantor must clearly identify the trust’s beneficiaries, including initial beneficiaries and future generations. The grantor defines the terms under which beneficiaries will receive distributions. Finally, a comprehensive inventory of the assets that will fund the trust is required, such as cash, securities, or real estate, along with corresponding documentation.

The Establishment Process

The first action is the drafting of the trust agreement by a qualified estate planning attorney. This legal document outlines in detail the grantor’s wishes, the powers of the trustee, the identity of the beneficiaries, and the rules for distributing assets.

Once the trust document is finalized, the next step is its formal execution. This involves the grantor and the named trustee signing the agreement in the presence of a notary public. Notarization provides official verification of the signatures, making the document legally binding.

The final step is funding the trust, which is the legal transfer of the inventoried assets into the trust’s ownership. This is an active process that requires formally retitling each asset. For real estate, this means preparing and recording a new deed that lists the trust as the owner. For financial accounts, the account registration is changed from the grantor’s name to the name of the trust.

Trust Administration and Distributions

After the trust is funded, its ongoing management, known as trust administration, begins. The trustee is responsible for prudently managing and investing the trust’s assets to preserve and grow the principal. The trustee must also maintain meticulous records of all transactions.

A significant administrative duty is handling tax obligations. Because a dynastic trust is a separate taxable entity, the trustee must file an annual federal income tax return using IRS Form 1041. This form reports any income earned by the trust. If income is distributed, the trust receives a deduction, and beneficiaries report that income on their personal returns.

Distributions to beneficiaries are made according to the terms in the trust document. Some trusts require mandatory distributions, such as all income earned each year. More commonly, distributions are discretionary, giving the trustee flexibility to make payments based on needs and broad standards set by the grantor, such as for health, education, or support. This discretionary power allows the trustee to adapt to changing circumstances and provides protection for the trust assets from beneficiaries’ potential creditors or divorce proceedings.