The generation skipping-trust (GST) is a powerful estate planning tool that can help protect your wealth for generations to come. That’s because this type of irrevocable trust allows you to pass on assets to your grandchildren and other members of future generations without incurring gift or estate taxes.
In this article, you’ll be exposed to the rules and regulations surrounding GSTs, the pros and cons of using them, and who they’re typically best suited for. We’ll also be answering some of the most frequently asked questions in regards to this trust, and provide you with actionable steps to create one for yourself.
Table of Contents
- 1 What is a Generation-Skipping Trust?
- 2 Generation-Skipping Trust Rules
- 3 Generation-Skipping Trust Pros and Cons
- 4 Who Should Use a Generation-Skipping Trust: A Trust for Grandchildren
- 5 Frequently Asked Questions
- 6 Generation-Skipping Trust Example
- 7 How CW O’Conner Can Help You Further
- 8 Download our 2023 Financial Planning Guide
What is a Generation-Skipping Trust?
A generation-skipping trust is an irrevocable trust that allows individuals to transfer assets to future generations (ex: grandchildren) without triggering gift or estate taxes. This type of trust is particularly useful for those who want to ensure that their wealth is protected for multiple generations.
When a GST is created, the grantor (i.e. the trust’s creator) transfers assets into the trust and appoints a trustee to manage and distribute the assets according to the trust’s terms. The distributions then skip a generation, and pass on to the grantor’s grandchildren or anyone that’s at least 37½ years younger than them (i.e. skip persons). This allows the assets to grow and compound over time, without being subject to estate taxes at each generation.
Generation-Skipping Trust Rules
While generation-skipping trust advantages are numerous, it’s important to first understand their rules and regulations. Otherwise, you won’t be able to leverage the full power this tool can offer when transferring and protecting your wealth.
Below, are list of GST rules you should note:
Generation-Skipping Transfer Tax (GSTT): There’s a generation-skipping transfer tax (GSTT) that can be applied to assets being transferred to skip persons. This tax matches the top federal estate tax rate (40%), and is paid on top of other applicable gift and estate taxes. The GSTT kicks in if the amount of assets being transferred exceeds, or was never subject to, the grantor’s GSTT lifetime exclusion amount (see next rule).
Generation-Skipping Transfer Tax Lifetime Exclusion: The GSTT exclusion is indexed for inflation each year, and in 2023, maxes out at $12.92 million for individuals and $25.84 for couples that are married. Any transfers or distributions from a generation-skipping trust that exceed this threshold will be subject to a GSTT along with any other gift and estate taxes that may apply.
Generation-Skipping Transfer Tax Annual Exclusion: The GSTT also has an annual exclusion. In 2023, you’ll be able to give $17,000 as an individual or $34,000 as a married couple to your grandchildren (or other eligible skip persons) without using up any of your GSTT lifetime exclusion.
Allocating the Generation-Skipping Transfer Tax Exclusion: If the grantor wants to avoid paying a GSTT when placing assets inside their generation-skipping trust, they’ll need to use some (or all) of their GSTT lifetime exemption. The exemption may be utilized for outright transfers along with transfers in trust. It’s also important to understand that when an allocation of your GSTT exemption is used on a transfer of your trust’s assets, any appreciation on such assets will be protected from any GSTT going forward.
Beneficiary Restrictions: Generation-skipping trusts are typically set up to transfer wealth to grandchildren. However, your trust’s beneficiary doesn’t have to be within your bloodline. They just need to be at least two generations younger. Therefore, you can use the trust to transfer assets to a grandchild or anyone that’s at least 37½ years younger than you.
Access For Children Being Skipped: Your next-in-line children (i.e. non-skip persons) can still benefit from a generation-skipping trust. There are no rules against them accessing earnings generated from the assets inside your trust as long as the original assets haven’t been distributed. Only skip persons may receive such assets.
Please Note: Presently, the Tax Cuts and Jobs Act is set to expire at the end of 2025. As a result, starting in 2026, the federal gift and estate tax exemption will be returning to its pre-2018 level ($5 million for individuals) with adjustments for inflation. So unless legislation changes, generation skipping transfer taxes may kick in at a much lower threshold.
Generation-Skipping Trust Pros and Cons
Asset Protection: Given the irrevocable nature of a GST, your assets can be protected from the claims of creditors and lawsuits. Additionally, the terms of your trust can limit the access financially irresponsible family members have to your assets.
Skipping a Generation of Estate Taxes: One of the biggest advantages of using a GST is the ability to skip a generation of estate taxes. Estate taxes are only accounted for when assets are transferred or distributed to your grandchildren (or other skip persons). However, if you pass assets to your children, who then give them to your grandchildren, the wealth ends up subject to two rounds of estate taxes instead of one.
Lasting Legacy: By using a GST you’re able to ensure the wealth of your estate is protected for a minimum of two generations. Both your children, and your grandchildren (or other eligible beneficiaries) can benefit financially from the terms of your generation-skipping trust.
No Impact On Your Children’s Estate: Assets inside your GST won’t be included in your child’s estate. This can be especially beneficial if your child is facing financial difficulties or is not capable of managing the assets responsibly. By holding the assets in the GST, you can protect them from creditors, lawsuits, and other potential risks.
Possible Generation-Skipping Transfer Taxes: One of the drawbacks of using a generation-skipping trust is that it may be subject to generation-skipping transfer taxes (GSTT). Unless the grantor uses their GSTT tax exemption to shelter the assets in their trust, this tax can be levied on transfers of property to skip persons, such as grandchildren or great-grandchildren. The GSTT can be as high as 40% and it’s paid on top of other applicable estate taxes, which can reach another 40%.
Administrative Concerns: Setting up and maintaining a generation-skipping trust can be administratively burdensome, as it requires ongoing management and monitoring by the trustee. This can include keeping track of the trust’s assets, making distributions to beneficiaries, and filing annual tax returns.
Possible Impact On Next-In-Line Children: A generation-skipping trust may not be ideal for children who are being skipped, as they may not have immediate access to the assets in the trust. Additionally, if the assets are held in the trust for a long period of time, the beneficiaries may not be able to use the assets for their own purposes, such as education or starting a business.
Irrevocability: GSTs are generally irrevocable, meaning that once assets are transferred into the trust, the grantor cannot change the terms of the trust or take back the assets even if doing so would be more beneficial.
Who Should Use a Generation-Skipping Trust: A Trust for Grandchildren
Generation-skipping trusts (GSTs) are best for individuals who want to pass on their wealth to future generations while minimizing estate taxes and protecting their assets from creditors and other potential risks.
They are often used by high net worth individuals, who are looking to pass on a significant amount of assets to their grandchildren or other skip persons, such as great-grandchildren or more remote descendants.
GSTs can also be beneficial for individuals who have children who may be struggling financially or have a history of financial difficulties, as the assets in the trust are protected from outside threats like lawsuits, and other fiscally irresponsible persons.
However, it’s always best to consult with an attorney or financial advisor to determine if a GST is the right choice for your specific situation. Depending on the amount of assets you’re looking to transfer, other estate planning tools may be worth exploring to avoid the risk of having to pay exorbitant generation-skipping transfer taxes and other applicable estate taxes.
Frequently Asked Questions
How Do Withdrawals Work with a Generation-Skipping Trust?
Withdrawals from a generation-skipping trust are typically made by the trustee, who has the discretion to distribute trust assets to the beneficiaries (skip persons) based on their needs and circumstances. The terms of the trust document will specify when and how withdrawals can be made, such as for specific expenses like those related to education or healthcare support.
When Does a Generation-Skipping Trust Terminate?
The terms of the trust document will specify when the generation-skipping trust will terminate. This could be at a specific date, such as a number of years after the trust’s formation, or upon the occurrence of a specific event, such as the death of the last beneficiary.
Are the Distributions of a Generation-Skipping Trust Taxable?
If assets inside a generation-skipping trust make a distribution to a beneficiary they may be subject to a generation-skipping transfer tax (GSTT). This can occur if the assets being distributed exceed the grantor’s lifetime GSTT exclusion, or if the grantor used none (or not enough) of their exclusion when initially placing assets inside their trust. In this case, the recipient of the assets (i.e. the beneficiary) will have to pay the GSTT on the distribution.
However, if the assets initially placed inside a generation-skipping trust do not exceed, or are fully covered by grantor’s GSTT lifetime exemption, then future distributions of such assets (including any appreciation) to beneficiaries will not be subject to a GSTT.
Are Generation-Skipping Trusts Irrevocable?
Generation-skipping trusts are irrevocable. Once assets are placed inside the trust, you will not be able to make changes to the trust’s terms or take back your assets. This ensures that the assets will be protected for the benefit of the skip persons.
Generation-Skipping Trust Example
Jennifer is a successful businesswoman and mother of two. She wants to ensure her children and grandchildren are taken care of financially after she passes away. But she also wants to minimize the amount of taxes her estate will have to pay. To accomplish these goals, Jennifer sets up a generation skipping trust (GST) and places $4 million of assets into the trust.
The beneficiaries of Jennifer’s GST are her grandchildren. The trust document specifies that the assets in the trust cannot be distributed to Jennifer’s children, but can be used for certain expenses such as education, healthcare and support for the grandchildren. It’s also specified that the assets must be held in trust for her grandchildren for a period of 30 years, at which point the trust will terminate and the remaining assets will be distributed to the grandchildren outright.
As the trustee of the trust, Jennifer can make distributions to her grandchildren based on their needs and circumstances, such as paying for college tuition or medical expenses. The GST is not subject to generation-skipping transfer taxes or estate taxes and it’s also not included in Jennifer’s children’s estate, which means that the assets held in the trust are protected from creditors, lawsuits, and other outside risks.
How CW O’Conner Can Help You Further
At CW O’Conner it’s a privilege to help our clients build wealth for generations to come. The best way to do that is to ensure they have the right estate plan in place.
Depending on the size of your estate, it may be worth looking into a generation-skipping trust. They’re a powerful vehicle in transferring wealth to future generations, and protecting it against outside forces.
As a team, we’ll help figure out if a generation-skipping trust is right for you. And we’re able to work with your attorney, or recommend one of our own, if we discover that’s the case. You’ll have a qualified professional at your side every step of the way.
If you’re ready to establish a generation-skipping trust, or have further questions on whether or not one may be right for you, please don’t hesitate to reach out. You can call us directly at 770-368-9919, or you can fill out a contact card, and we’ll reach out to you.
The opinions and analysis expressed herein are based on C.W. O’Conner Wealth Advisors, Inc. research and professional experience and are expressed as of the date of this report. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice.