Key Takeaways
- Transfers assets directly to grandchildren, skipping children.
- Helps avoid estate tax at children's generation.
- Subject to a 40% generation-skipping transfer tax.
- Uses lifetime exemption to shelter large transfers.
What is Generation-Skipping Trust?
A Generation-Skipping Trust (GST) is an irrevocable trust designed to transfer assets directly to beneficiaries who are two or more generations below the grantor, such as grandchildren, bypassing the grantor's children. This setup helps avoid a second layer of federal estate taxes commonly applied to the intermediate generation.
GSTs are particularly useful for preserving wealth across multiple generations while complying with the federal Generation-Skipping Transfer Tax (GSTT) rules.
Key Characteristics
Generation-Skipping Trusts have specific features that differentiate them from other estate planning tools:
- Irrevocable Nature: Once established, the trust cannot be modified or revoked without beneficiary consent.
- Tax Efficiency: Assets pass to skip persons without incurring estate taxes at the intermediate generation, subject to the GST exemption.
- Income Access: Children may receive limited income or principal distributions without triggering the GSTT.
- GSTT Compliance: The trust must meet IRS rules under 26 USC § 2632 to qualify, avoiding distributions exceeding 25% corpus to non-skip persons before age 46.
- Wealth Preservation: Enables assets to grow tax-free for grandchildren or later generations.
How It Works
You fund the trust with assets that will skip your children’s estate and pass directly to grandchildren or younger beneficiaries. The trust generally provides income to the children during their lifetime, while principal remains protected for the skip generation.
The trust leverages your lifetime GST exemption to shelter transfers from the 40% Generation-Skipping Transfer Tax, which applies in addition to estate or gift taxes. Proper allocation of this exemption is critical to minimizing tax liability. This strategy aligns with estate planning techniques like the A-B Trust, but focuses on bypassing an entire generation of estate taxation.
Examples and Use Cases
Generation-Skipping Trusts are typically used by high-net-worth families aiming to transfer significant wealth efficiently:
- Dynasty Trusts: Families may establish GSTs to continue benefiting multiple generations, especially in states that allow trusts to last indefinitely.
- Large Estates: A grandparent funding a GST with $20 million can allow children to receive income while the principal passes tax-free to grandchildren, similar to strategies involving companies like Delta and American Airlines that focus on long-term capital growth.
- Investment Growth: Using low-cost funds such as those recommended in best low-cost index funds within a GST can maximize wealth accumulation for skip generations.
Important Considerations
While Generation-Skipping Trusts offer significant tax advantages, they require careful planning and professional guidance due to their complexity and irrevocable nature. Missteps in exemption allocation can trigger substantial GSTT liabilities.
Additionally, distributions to skip persons may still incur taxes, and state laws could affect trust duration and administration. Incorporating valuation techniques like discounted cash flow analysis helps in accurate asset appraisal and tax compliance.
Final Words
A Generation-Skipping Trust can effectively preserve wealth across multiple generations while minimizing estate taxes. Consult a qualified estate planning professional to evaluate if a GST fits your long-term financial strategy.
Frequently Asked Questions
A Generation-Skipping Trust (GST) is an irrevocable trust that allows assets to be transferred directly to beneficiaries two or more generations below the grantor, typically grandchildren, bypassing the grantor's children to avoid a second layer of federal estate taxes.
A GST reduces estate taxes by skipping the intermediate generation, usually the grantor's children, which prevents a second round of federal estate taxation. Assets transferred into the trust grow and pass to grandchildren or later heirs without being taxed again at the children's generation.
The GSTT is paid by different parties depending on the situation: the grantor pays tax on direct skips, the recipient pays on taxable distributions, and the trustee pays on taxable terminations. This tax applies in addition to estate or gift taxes when transfers exceed the grantor's GST exemption.
The GST exemption is a lifetime amount (aligned with the estate/gift tax exemption, $15 million in 2026) that a grantor can allocate to shelter transfers to skip persons from the generation-skipping transfer tax. Properly using this exemption allows wealthy individuals to transfer large sums without incurring GSTT.
Yes, children typically receive limited access to the trust’s income or principal during their lifetimes, but the trust’s principal mainly benefits the skip generation, such as grandchildren, thereby preserving wealth across multiple generations.
Yes, to qualify as skip persons, beneficiaries must be at least 37.5 years younger than the grantor or two or more generations below. This typically includes grandchildren or later descendants, ensuring the trust skips the immediate next generation.
A GST can potentially continue indefinitely, allowing assets to grow and pass tax-free across generations, but it must comply with state laws like the rule against perpetuities, which may limit how long the trust can last.
GSTT is triggered by three main events: direct skips (outright gifts to skip persons), taxable distributions (payments from the trust to skip persons), and taxable terminations (when a non-skip beneficiary’s interest ends and benefits shift to skip persons).
