How much estate tax does a dynasty trust save? A worked example

The trust against outright bequests, generation by generation, why the saving compounds to far more than 40 per cent, and what growth, payouts and GST exemption do to it.

Julian R. Sterling · from The Family Office Professional

A dynasty trust saves the transfer tax at every generation, and the saving compounds. On an illustrative $15m funded with GST exemption and growing 6.0 per cent a year, the trust holds $2,842.0m after three 30-year generations, against $613.9m if the same money passes outright and bears 40 per cent estate tax at each death. The family keeps 4.63 times as much, not the 1.67 times a single generation suggests.

Worked in full in The Family Office Professional by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

What a dynasty trust does

A dynasty trust is an irrevocable trust designed to last for several generations, as long as the governing state's law allows. The family allocates its generation-skipping transfer (GST) tax exemption to the trust when it is funded, so the trust has an inclusion ratio of zero: no estate tax when a beneficiary dies, because the beneficiaries never own the assets, and no GST tax when the assets pass to grandchildren and beyond. Everything the trust earns after funding sits outside every future estate.

The assumptions

Illustrative family, two routes
Input	Value
Amount funded, with GST exemption allocated	$15m
Net growth after costs and income tax, no distributions	6.0% a year
Length of a generation	30 years
Generations	3 (90 years)
Estate tax rate on outright transfers	40%
Children per generation	3

The outright route assumes each generation's own exemption is used on its other assets, so the inherited block bears the full 40 per cent. That is the right comparison for a family whose wealth well exceeds its exemptions.

Step 1: the trust

Trust value = Funding × (1 + g)^{generation years × generations}

= $15m × 1.06⁹⁰ = $2,842.0m

Excel: =15*(1+6%)^90

Step 2: the outright route

Each generation: inherited amount × (1 + g)³⁰ × (1 − 40%)

After three generations = $15m × 1.06⁹⁰ × 0.60³ = $2,842.0m × 21.6% = $613.9m

Generation by generation ($m)
Generation	Dynasty trust	Outright, before tax	Estate tax	Outright, after tax	Trust / outright
1	86.2	86.2	34.5	51.7	1.67
2	494.8	296.9	118.8	178.1	2.78
3	2,842.0	1,023.1	409.2	613.9	4.63

The result

The trust ends $2,228.1m ahead. Only $562.5m of that is tax actually paid on the outright route; the other $1,665.6m is the growth the paid tax would have earned. That is why the ratio rises from 1.67 after one generation to 2.78 and then 4.63: each tax payment removes capital that would otherwise have compounded for the remaining generations. Put another way, the outright route keeps 21.6 per cent of what the trust keeps and loses 78.4 per cent, not 40.

In real terms, at 2.5 per cent inflation the trust's $2,842.0m is $307.9m of today's money and the outright route's $66.5m. Shared among 27 great-grandchildren, that is $11.4m each in today's money from the trust, against $2.46m.

What if growth is different, or the trust pays out?

Value after 90 years ($m)
Net growth	Dynasty trust	Outright	Difference
4%	511.8	110.5	401.2
6%	2,842.0	613.9	2,228.1
8%	15,283.7	3,301.3	11,982.4

The ratio is the same 4.63 at every growth rate, because the tax is a fixed share taken three times. Growth sets the size of the prize, not the multiple. A trust that pays beneficiaries 2.0 per cent a year grows at 4.0 per cent and holds $511.8m after 90 years. Those distributions are not lost to the family, but once paid out they sit in the beneficiaries' own estates and are taxed on the outright route.

The common mistakes

Valuing the saving as 40 per cent once. 40 per cent of the final trust is $1,136.8m. The true difference is $2,228.1m, almost twice as much, because the saving compounds.
Funding the trust without allocating GST exemption. With an inclusion ratio of one, GST tax at 40 per cent applies at each generation skip and the trust ends at the same $613.9m as the outright route. The structure only works with the exemption allocated.
Ignoring the trust's income tax. Non-grantor trusts reach the top income tax bracket at a low level of income, so the net growth assumption matters more than any other input. Structuring the trust as a grantor trust, so that the founder pays its income tax, keeps growth in the trust; the same idea drives a sale to an IDGT.

Takeaway

Trust = funding × (1 + g)⁹⁰; outright = the same × 0.60³. The ratio is 1 / 0.216 = 4.63 after three generations, whatever the growth rate.
On $15m at 6.0 per cent: $2,842.0m against $613.9m, of which only $562.5m is tax paid; the rest is lost compounding.
Pair the trust with a technique that moves growth into it at no gift cost, such as a GRAT, and the multiple applies to more capital.

The book's own case of a fortune split across generations, and what separate offices cost the branches, is in the free companion files for this book.

Questions readers ask

How do you calculate the benefit of a dynasty trust?

Grow the funding at the trust's net return for the whole horizon, then compare with the same growth reduced by the estate tax at each generation: trust = F x (1 + g) to the power 90, outright = trust x 0.60 cubed for three generations at 40 per cent. On $15m at 6.0 per cent that is $2,842.0m against $613.9m.

Why does a dynasty trust save more than the 40 per cent tax rate?

Because each tax payment also removes the growth it would have earned. Over three generations the outright route pays $562.5m of tax but ends $2,228.1m behind the trust: the other $1,665.6m is compounding lost on the money paid away. The family keeps 21.6 per cent outright, so the trust ends 4.63 times larger.

What happens if GST exemption is not allocated to a dynasty trust?

The trust has an inclusion ratio of one and generation-skipping transfer tax at 40 per cent applies at each skip. In the worked example it would end at $613.9m after 90 years, the same as passing the money outright, so the structure would save nothing.

Read the whole case

This article is one calculation from The Family Office Professional. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.

Get the book on Amazon →Free companion files

Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada

Also on this site

How does a GRAT work? A worked example with the 7520 rateA zeroed-out GRAT passes only growth above the 7520 rate: 10 million growing 12 per cent in a two-year GRAT at 5.0 per cent leaves heirs 1,142,537 gift-tax free.
How does a sale to an IDGT work? A worked exampleThe trust buys assets for an AFR note and keeps the growth above it: $20M growing 7 per cent, sold for a 4.00 per cent note, leaves heirs $18.13M after 9 years.
What spending rate preserves a family's wealth across generations?Net return, less inflation, less the growth in heirs. On $500m earning 6.2 per cent net, that is 1.3 per cent a year, not the 3.7 per cent an endowment rule allows.
At what level of wealth does a family office start to pay?A five-person office costs $2,442,000 whether it oversees $100m or $2bn. Against a tiered multi-family schedule the two curves cross exactly once: at $567m.
Can a private foundation pay out 5 per cent a year forever?Only at about 8.10 per cent gross: at 7.00, the 5 per cent payout, fees and inflation leave 72.3 of each 100 in real terms after 30 years.
Does diversifying a concentrated stock position repay the tax?Selling $300m of a nil-basis stake costs $71.4m of tax. Lower volatility drag repays it in 5.3 years of median growth, though never on expected values.

Reading guide: private equity and private markets → · All 1340 articles →

If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.