A generation-skipping trust is used to transfer money or other assets to someone who is at least 37.5 years younger than you. The primary purpose of a generation-skipping trust is to minimize estate taxes and generation-skipping transfer taxes.
Normally, very wealthy estates have to pay an estate tax each time the estate is passed from one person to another. The federal estate tax applies to estates worth more than $12.92 million in 2023 and 12 states (plus Washington, D.C.) levy their own estate taxes. Some people may try to avoid tax by passing everything to their grandchildren instead of their children, but this also comes with a tax — the generation-skipping transfer tax — which is levied in addition to estate tax. A properly constructed generation-skipping trust can help minimize both types of taxes.
Traditionally, people use a generation-skipping trust to bypass their children and pass assets directly to their grandchildren or even great-grandchildren. A recipient of the trust assets is known as a skip person and while grandchildren are common skip persons, the trust beneficiaries don’t have to be related to the grantor (trust creator). The beneficiary could even be another trust. The only big exception is that your spouse cannot be the trust beneficiary.
Since generation-skipping trusts are complex, you will need to work with an estate planning attorney to create one. You should also create one as soon as you can, to ensure your estate plan is as effective as possible.
The main purpose of a generation-skipping trust is to avoid paying estate tax more than once.
The trust beneficiaries are called the “skip persons” and they don’t need to be related to the trust creator.
Generation-skipping trusts are created as irrevocable trusts.
Generation-skipping trusts are complicated and you will need to work with an estate planning attorney to create a strong one.
The benefits of a generation-skipping trust
The primary objective of a generation-skipping trust is to help someone minimize their estate taxes when passing on their money and assets. Normally, very wealthy estates (worth more than $12.92 million in 2023) have to pay estate tax based on the value that is being passed on to others. For example, if someone passed a wealthy estate to their son and then the son passed the estate to his children, estate tax would be assessed twice (once at each transfer). By skipping over the son’s generation and passing the estate directly to the grandchildren, the estate tax is only assessed once. However, another tax, called the generation-skipping transfer tax, would still be levied on this generation-skipping bequest. To minimize your GST tax, you could pass assets through a generation-skipping trust.
Generation-skipping trusts also don’t have to disinherit any of the skipped generations. In fact, it’s common for generation-skipping trusts to provide income to multiple generations over the course of decades. When planning your trust, it’s important to consider what you want to give to the generation you’re skipping.
Generation-skipping trusts & taxes
A well made generation-skipping trust will help the grantor avoid multiple rounds of estate tax in the future, but there are three main types of taxes that wealthy individuals and estates may need to consider:
Generation-skipping transfer tax (GST tax)
Who has to pay estate taxes?
An estate owes estate taxes if it’s worth more than the estate tax exemption. At the federal level, the estate tax applies to an estate worth more than $12.92 million in 2023. The lifetime exemption amount changes annually to keep up with inflation. There are also estate taxes in 12 states and the District of Columbia. Some estate tax exemptions at the state level are the same as the federal exemption, while others are less than $1 million. States also set their own tax rates.
The lifetime estate tax exemption is also referred to as the unified credit, because it works in conjunction with gift tax and the generation-skipping tax.
You are allowed to give gifts (money, property, or other assets) during your lifetime without paying any taxes, as long as the total value of your gifts doesn’t exceed your lifetime exclusion, which is the same as your estate tax exemption: $12.92 million in 2023. However, there is also any annual exclusion of $17,000 and each time you give a gift worth more than that amount, your lifetime exclusion (and also your estate tax exemption) decreases by the excess value of the gift. So if you’ve given away $5 million worth of gifts (beyond the annual limits) during your lifetime, your estate will owe tax if it’s worth more than $7.92 million if you die in 2023.
Generation-skipping transfer tax
To prevent someone from avoiding multiple rounds of estate tax, there is also a generation-skipping transfer (GST) tax. The GST tax applies when someone gives direct gifts of money or other assets to a person who’s at least 37.5 years younger than them, even through a trust. The GST tax rate is a flat 40% on the value of transfers that exceed the exemption. The GST tax exemption is $12.92 million in 2023 — the same amount as the estate tax exemption and the lifetime gift tax exclusion — so most people do not need to worry about paying it. The GST tax is also called the GSTT, or simply the transfer tax.
However, if you have a very wealthy estate, a properly crafted generation-skipping trust can be an effective tool for minimizing the tax liability for you, your estate, and your heirs. To better understand the complexities of this tax and a trust, it’s best to talk with either a financial advisor or an estate attorney.
How to create a generation-skipping trust
Generation-skipping trusts are complicated and the exact details of your trust will depend on your specific goals. For example, do you want to provide trust income to people in multiple generations? Do you know how your overall estate plan could affect a surviving spouse?
A generation-skipping trust must be constructed with attention to IRS code to ensure you receive its full benefits, so you need to work with an experienced estate planning attorney. This trust and other trusts that preserve tax benefits must be irrevocable in nature, which means you can neither modify it nor retain the ability to do so. (At the same time, you may be able to serve as trustee and direct, to an extent, how the funds assets are managed or invested.)
Also consider making your trust sooner rather than later. Having the trust created decades before your death will help you make other important estate planning decisions, like whether you want to make large gifts to anyone, how to structure your last will and testament, and how your estate plan affects your spouse.