A Generation-Skipping Trust (GST) is a specialized irrevocable trust designed to transfer assets directly to beneficiaries at least two generations younger than the grantor—commonly grandchildren—while avoiding or minimizing the federal generation-skipping transfer tax (GST tax). This estate planning tool prevents the assets from being taxed multiple times across generations.
How a Generation-Skipping Trust Works
When someone passes down wealth, estate taxes may apply to the estate before assets reach the heirs. If inheritance passes from grandparents to children, and then to grandchildren, the assets can be taxed twice—once at the grandparent’s estate and again at the child’s estate. A GST allows assets to skip the intermediate generation and go directly to the grandchildren, sidestepping that second layer of estate taxation.
Key components include:
- Grantor: The individual who creates and funds the trust.
- Trustee: The appointed person or institution responsible for managing the trust assets according to the grantor’s instructions. Learn more about trustees here.
- Beneficiaries: Typically grandchildren or younger generations who receive the trust assets.
- Irrevocability: GSTs are irrevocable, meaning once assets are placed in the trust, they generally cannot be withdrawn or changed, which is important for tax purposes.
The GST tax is a separate federal tax applied at a flat rate of 40% to transfers that skip a generation. However, for 2024, each individual has a generous lifetime GST tax exemption of $13.61 million, which can shield transfers up to this amount from the tax. Proper allocation of this exemption is crucial to avoid unexpected tax liabilities.
Why Use a Generation-Skipping Trust?
A GST offers both tax efficiency and control over asset distribution:
- Tax Savings: It prevents double taxation as assets bypass the children’s estates and are not subject to estate tax again when passed to grandchildren.
- Controlled Access: Grantors can specify when and how beneficiaries receive assets, for example, restricting distributions for education or medical expenses or setting ages at which beneficiaries receive funds.
- Large Estate Planning: Particularly beneficial for individuals with estates exceeding the federal estate tax exemption threshold.
For more on managing estate taxes, see our articles on Estate Tax Planning and Federal Estate Tax.
Types of Generation-Skipping Trusts
- Irrevocable Lifetime Trust: Established during the grantor’s lifetime. Assets transferred here are generally removed from their taxable estate. For example, Sarah establishes an irrevocable GST to fund her granddaughter’s education, using her GST exemption.
- Testamentary Trust: Created through the grantor’s will and enacted upon death. This trust is funded by the deceased’s estate with specific terms for distribution to grandchildren.
Important Considerations
- Exemption Allocation: Properly allocate your GST tax exemption to avoid GST tax on future transfers.
- Choosing the Trustee: The trustee has significant responsibility overseeing the management and distribution of assets. Select someone reliable and knowledgeable.
- Irrevocability: Once funded, the trust terms cannot be easily changed.
- State Taxes: Some states have estate or inheritance taxes that GST rules may not override.
Common Misconceptions
- GST tax is different from gift tax, even though both relate to wealth transfer.
- Not every trust that benefits grandchildren is a GST; the generation-skipping transfer tax applies based on IRS rules.
- Failure to allocate exemptions can incur unexpected taxes on assets’ appreciation within the trust.
Real-World Example
Maria, a grandparent with $20 million in estate assets, wants to leave $1 million to her grandchildren without double taxation. By creating a GST and allocating her $1 million GST exemption, she ensures those assets are not taxed at her child’s estate level, preserving more wealth for her grandchildren.
Additional Resources
- IRS Estate and Gift Tax Information: IRS.gov Estate and Gift Tax
- Learn more about trusts: How to Set Up a Trust
In summary, a Generation-Skipping Trust is a powerful estate planning strategy for transferring wealth efficiently across multiple generations while minimizing federal taxes. Consulting a qualified estate planning attorney is essential to ensure the trust aligns with your financial goals and complies with current laws.