What Dynasty Trusts Are, How They Work, and Better Options in California

You may have heard the term “dynasty trust” if you’ve ever wondered how some families pass down wealth from one generation to the next while paying as little tax as possible, protecting their assets, and keeping their family values.

A lot of people don’t understand these trusts, but they can be very useful, especially for people in California.  Below, we explain what a dynasty trust is, how California families usually set one up, when it makes sense, and what other tools might help you reach your goals with less trouble.

What is a dynasty trust?

A dynasty trust is an irrevocable trust that lasts for a long time, often for many generations. It is meant to:

• Hold assets in trust for kids, grandkids, and beyond
• Keep those assets safe from creditors, divorcing spouses, and lawsuits that come from beneficiaries.
• Use lifetime tax exemptions and careful planning to lower or avoid estate taxes for each generation.
• Use guardrails, incentives, and professional management to encourage responsible use of wealth.

The word “dynasty” means length and purpose, not a legal term.  In practice, it’s an irrevocable trust with rules that let it last for many years, often outside of California. It also uses the federal generation-skipping transfer (GST) tax exemption so that assets can pass down without having to pay estate taxes at each step.

Is it possible to set up a dynasty trust in California?

California has a version of the “rule against perpetuities,” which says how long a trust can last.  California isn’t usually thought of as a “perpetual trust” state, even though there are some technical differences.  That’s why a lot of people in California choose to put their dynasty trust in a state with better laws, like Nevada, South Dakota, Delaware, or Alaska. These states have laws that allow very long or even permanent trusts and have strong features for protecting assets and managing trusts.

This is known as choosing the trust’s situs, or legal home.  If you set up an out-of-state trust correctly (usually with a trustee and administration that are not in California), you can still live in California and use it.

The main pros and cons for people in California

Possible benefits

• Long-term protection: If done correctly, assets can be safe from beneficiaries’ creditors, lawsuits, and divorces.
• Tax efficiency: If you give your federal GST exemption to the trust, you may not have to pay estate tax on the trust assets at every generation.
• Professional oversight: Independent trustees handle investments, distributions, and compliance, which can help keep the peace in the family.
• Values and incentives: You can link distributions to things like education, career goals, or giving to charity.

Important Considerations

• Income Tax: California may tax trust income if the trustee or beneficiary lives in California or if the income comes from California. Designing carefully with your CPA is very important.
• Property tax (Prop 19): If you transfer California real estate, it could trigger a reassessment unless you follow strict parent-child rules and timing. Dynasty trusts can make this more difficult, so think about it before putting real estate into a trust.
• Cost and complexity: These trusts need to be carefully written, managed on an ongoing basis, and kept up with taxes.
• Irrevocability: Once the trust is funded, you can’t change it, so make sure it has some flexibility (trust protectors, decanting, and directed-trust features).

How people usually use dynasty trusts

Here’s a common plan for clients:

1. Make your goals clear. Are you mostly interested in protecting your assets, saving money on taxes, taking care of your family, keeping your privacy, or all of the above? Your goals decide how the trust will work, such as when distributions will happen, what incentives will be offered, or what “health, education, maintenance, and support” standards will be used.
2. Pick the situs and the trustee. If you want protection that lasts a long time and is very strong, think about a state that is known for dynasty trusts.  To support the chosen situs and improve tax positioning, hire a professional, independent trustee from another state and manage the trust in that state.
3. Name a trust protector. A trust protector, who is a neutral third party, can change some of the terms without going to court if the law or the family’s needs change.  This makes a structure that can’t be changed more flexible.
4. Plan your taxes.
   1. Gift and estate tax: You can put money into the trust while you’re alive using part of your federal lifetime exemption, or you can do it after you die through your estate plan. The current federal exemption is at an all-time high, so timing is important.
   2. GST tax: Give the trust a GST exemption to try to protect it from transfer taxes for many generations.
   3. State income tax: Work with your lawyer and CPA to make sure you follow the rules for trustee residency, administration, and California sourcing.
5. Put money into the trust. Funding can come from marketable securities, interests in a family LLC or closely held business, life insurance (through an ILIT structure – see below), and sometimes even real estate (after a thorough review of the property taxes).
6. Make rules for how to distribute things that work. A lot of clients like the “lifetime access” model. Beneficiaries get distributions for health, education, maintenance, and support, as well as extra amounts, while the principal stays safe.
7. Add tools that make things more flexible.
   1. Decanting. Decanting means moving assets to a new trust with better terms if the law or the situation changes (but only if state law allows it).
   2. Directed trust: Give specialists different roles in investing, distributing, and being a trustee.
   3. Trustee succession plan: Make sure that the handoffs go smoothly for decades.

When is it a good idea to use a dynasty trust?

• You want to plan for multiple generations while keeping your assets safe.
• Your estate is big enough that you need to worry about future estate taxes.
• You want to keep family values alive through structured distributions and governance.
• You own things that will benefit from centralized professional management for many generations.
• If your estate is small or your goals are short-term, a simpler approach might be better (and less expensive to run).

Smart alternatives

Not everyone needs a dynasty trust for their estate.  These tools can be easier or more focused, depending on what you want to do:

• Revocable Living Trust with basic GST planning. The California baseline: doesn’t go through probate, keeps things private, and can have sub-trusts for kids.  You can add some GST features without going “full dynasty”.
• Children’s Lifetime Discretionary Trusts. Irrevocable trusts set up while you’re alive for certain beneficiaries. They protect your assets and are less complicated than a multi-state dynasty plan.
• SLAT (Spousal Lifetime Access Trust). Allows you to make a completed gift for tax reasons while the spouse who didn’t give it keeps limited access during their lifetime.  A popular way to lock in today’s federal exemption, but it takes careful planning and writing between spouses.
• ILIT (Irrevocable Life Insurance Trust). Keeps the money from your life insurance policy out of your taxable estate and gives your heirs cash for estate taxes or to even things out among your kids.
• Family LLC/FLP. Not a trust, but a great tool to have.  Centralizes the management of investments or real estate, may offer discounts on valuations, and can be owned in part by trusts.
• Trust for Qualified Terminable Interest Property (QTIP). A marital-deduction trust for blended families that protects the principal for children from a previous marriage while making sure that the surviving spouse is taken care of.
• 529 Plans and Trusts for Education. Targeted funding for education without the trouble of a dynasty structure.
• Charitable Trusts (CRT/CLT) or a Private Foundation/DAF. If giving back is important to you, these can help you pay less in taxes and build your family’s legacy in a mission-driven way.

Key California pitfalls to avoid

• Ignoring rules about property taxes. If you move a rental or vacation home into an irrevocable trust without looking at Proposition 19, you could end up with painful reassessments and higher taxes each year.
• Trustee residency mistakes. A California co-trustee who means well can accidentally bring an out-of-state trust into California’s tax net.  Be careful when choosing trustees.
• No built-in flexibility. Laws and family relationships change over time.  To make changes, use trust protectors, decanting language, and directed-trust features.
• Not enough money or too much money. Make the plan the right size.  Before giving large assets to an irrevocable trust, make sure you have enough cash on hand for your own retirement.

 How to get going

1. Talk about setting goals. What do you want your money to do? Protect, educate, start businesses, help charities, or a mix of these things?
2. Talk to your advisors about the numbers. Get your estate lawyer, CPA, and financial advisor to work together to look at how taxes will change, how much cash you need, and how to plan your investments.
3. Choose the site and the rules. Choose the legal home, the trustee lineup, and whether or not to have a trust protector and a directed-trust structure.
4. Write, pay for, and keep up. The first step is to write a good plan. The second step is to stick to the plan and keep it going.

The bottom line

A dynasty trust can be a great way for some families in California to leave behind a legacy, but it’s not the best option for everyone.  Setting clear goals, carefully coordinating taxes, and leaving room for flexibility in the long term will get you the best results.  We can help you figure out if a dynasty trust or a simpler option is right for you.

Filippi Law Firm, P.C. helps families in California with trust design, multi-state situs strategies, and practical, values-based legacy planning.  Call our Rocklin office to set up a meeting if you’d like a personalized assessment.