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What Is a Generation Skipping Trust?

In short, the pros certainly outweigh the cons when having a generation skipping trust. Our users have found that Trust & Will is the best place to get started with a generation skipping trust.

A “Generation Skipping Trust” is a legal document that provides you the ability to skip a generation when passing on assets. You can leave your estate to your grandchildren, great grandchildren, or other eligible “skip person” family members. This is an irrevocable trust that allows you to skip one generational round and it’s main aim is to lower estate tax liability. 

Most people leave their assets to their spouse or children, this is what differentiates a generation skipping trust. If you want to pass on your inheritance to your grandchildren, but don’t want it to endure two rounds of estate taxes (when it is passed from grandparents to child, then from child to grandchild). It is one of the most efficient ways to pass money to a grandchild through this trust since you would pay estate taxes only once. 

How a Generation Skipping Trust Works

As the name suggests, a generation skipping trust jumps over one generation and leaves the second generation as the beneficiary. How does this work though, who should even think about establishing one, and what exactly are all of the tax considerations? 

How Does a Generation Skipping Trust Work?

A generation skipping trust is a legally binding trust that skips a generation, as the title suggests. Assets within the trust skip a generation. In other words, assets go from grandparent to grandchild, while skipping the children for example. Money is never owned by the children in this case, it skips them entirely. Because of this, the grandchild would be designated as the “skip-person”.

There are rules for who can be designated as the skip person. A natural person assigned to a generation that is two or more generations below the settlor’s generation. The beneficiary does not have to be a blood relative. You can designate anyone who is at least 37 ½ years younger than you as the beneficiary of a generation-skipping trust. Grandchildren are the most popular, but can also be a great niece or great nephew.

Who Should Use a Generation Skipping Trust?

Generation skipping trusts are used mainly for large estates, one that is most likely to be hit with federal estate taxes (one where your children are most likely to pay the estate tax). If you are someone who has a high net worth, and do not want to saddle your children with the estate tax, this would be a good method to preserve capital as well as providing for future generations. 

Money or assets in the trust are never owned by the children of the originator of the trust, it passes directly to the following generation, but this doesn’t stop the children from receiving income from the investments

What Are the Associated Taxes?

You may be asking what all the fuss is about with generation skipping trusts and taxes. What kind of taxes are these trusts trying to avoid? It is best to understand all of the possible taxes that come with estates.

The United States has taxed estates of decedents since 1916. The federal estate tax applies to the transfer of property at death. 

They have taxed “Gifts” since 1924. The “Gift Tax” applies to transfers made while a person is living. The “Gift Tax” provides a lifetime exemption of $11.58 million per donor in 2020. This exemption is the same that applies to the estate tax and is integrated with it. In other words, gifts reduce the exemption total that is available for estate tax purposes. Beyond the exemption, donors pay the gift tax at the estate tax rate level which caps at 40 percent.

In 1976, Congress enacted the generation-skipping transfer (GST) tax and linked all three taxes into a unified estate and gift tax. This prevents families from avoiding the estate tax for several generations by making gifts directly to grandchildren or great-grandchildren, etc. The generation-skipping transfer tax is an incremental tax on a transfer of property that skips a generation.

Using the exemption and the top tax rate under the estate tax, the GST tax effectively thrusts a second layer of tax on wealth transfers to those recipients who are two or more generations younger than the donor. The tax applies only to the portion of the estate’s value that exceeds an exemption level as mentioned. The exemption level is indexed for inflation reaching $11.58 million in 2020 (and twice those amounts for married couples).

Pros and Cons of a Generation Skipping Trust

Depending on the person you ask in the family, there may be differing thoughts on what the pros and cons of this type of trust are. For instance, the child might feel like they are getting the short end of the stick, while the “skip person” reaps the rewards. One thing everyone can probably agree on though, is that less taxes on the estate is a good thing. 

Pros of a Generation Skipping Trust

The skipped generation may not get the full access to all of the assets, but there are still some benefits for them in addition to their grandchildren (if they are chosen to be the beneficiaries). Some of the other pros for this type of trust include:

Pros

  • Your children will still be able to access any income that the assets produce. As long as the original assets remain in the trust for the skip person, there is no rule that prohibits the skipped generation from accessing earnings on the assets in the trust. Even if the trust isn’t in their name
  • Eliminates one round of estate taxes from the passing down of your inheritance
  • Originator of the trust has full control over the beneficiary designation. For example, if one of the grandchildren has terrible spending habits. There are provisions that can be put in place to protect for this 

Cons of a Generation Skipping Trust

Again, the downsides of this type of trust depends on whose lens you are looking through. If it is through the grandchild, you may not view these as strongly. If you are another party involved though, some of the cons for this type of trust include:

Cons

  • Generation Skipping Trusts are irrevocable, meaning you cannot remove assets once they are placed within the trust
  • The children of the originator of the trust do not own the assets within the trust ever 

How and Where To Start a Generation Skipping Trust

Today its much easier to get started with forming a generation skipping trust. You can get started online and skip the need to prospect and hire an attorney. Here are some of our favorite online places to get started.

  1. TrustAndWill.com — Trust & Will provides you with everything you need in order to get your trust started easily. Just select one of their packages and you will be guided to a trust tailored to your needs: See pricing here.
  2. Legal Zoom — Legal Zoom is an extremely reputable company focusing on estate planning. To get started with establishing a trust, head to Legal Zoom now: See pricing here.
  3. Estate Planning Attorney — You can still contact your attorney if you want a more personal touch. Feel free to get in touch with an estate planning attorney that can guide you through establishing your generation skipping trust.

Final Thoughts: Start Planning Your Estate

GST’s probably aren’t necessary for smaller estates. You can have one, but most likely not worth the effort put into it. As mentioned previously, the benefits are enhanced with the higher your net worth is. This is the case especially if you and your family have an estate that is bordering, or above the estate tax threshold.

To determine if this type of trust would be a good idea or not, you should discuss with a financial advisor as soon as you can. 

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