Estate planning is a primary concern for many of our clients. Capital preservation is always top of mind as we explore ways in which they can pass as much of their estate along to their children and grandchildren without overpaying in taxes.
For grandparents who envision a legacy that spans generations, a generation-skipping trust (GST) may be the ideal vehicle. Typically, any attempt to transfer estate assets directly to a generation other than your children would trigger a generation-skipping transfer tax (GSTT), which is separate from and in addition to an estate tax. A properly drafted GST can cleanly and directly facilitate the transfer of money to your grandchildren, effectively skipping over your children and reducing the estate tax burden on the money.
What is a Generation-Skipping Transfer Tax?
As the name implies, the Generation-Skipping Transfer Tax (GSTT) is a transfer tax imposed when you try to bypass your children in favor of younger generations to avoid potential estate taxes upon your children’s deaths.
The GSTT is calculated based on the maximum estate tax rate of 40% on transfers that exceed the lifetime generation-skipping tax exemption of $12.06 million per individual (for 2022).[i] That amount is adjusted each year for inflation, but in 2026, it is scheduled to revert to a $5 million baseline unless Congress acts.
In conjunction with your tax and estate professional, we help our clients take advantage of some workarounds that can open up wealth-building and preservation opportunities.
How Does a Generation-Skipping Trust Work?
A generation-skipping trust is a legally binding trust that allows estate assets to skip over the next generation (your children) to the following one (your grandchildren). At no time is the money ever owned by the generation being skipped as it passes directly to the following generation.
The trust beneficiaries can be anyone, not just blood relatives, who are at least 37.5 years younger than the grantor who is not also a spouse or ex-spouse. The recipient can be a great-nephew or niece, or even a family friend.[ii]
Why Use a Generation-Skipping Trust?
If your goal is to have your legacy reach your grandchildren, a GST facilitates the transfer nicely. More importantly, it prevents the transferred funds from being taxed twice. If the funds were initially transferred to your children, who then pass them on to their children, they would be subject to estate or inheritance taxes upon both transfers.
Under federal estate tax laws, estates larger than $12.06 million per individual and $24.12 per couple (for 2022) are subject to an estate tax at a maximum rate of 40%.[iii] Some states impose their own estate taxes. Generally, estate taxes are paid before any money is transferred to beneficiaries. Some states also impose an inheritance tax, which is paid by the recipients.
When you use a GST, you essentially avoid the estate and inheritance tax your children would have paid if the money had been transferred to them. In effect, the GST enables you to preserve more of your wealth for future generations.
When a Generation-Skipping Trust Makes Sense: Capital Preservation
We have found that GSTs can be an especially effective tool for clients with large estates that will likely be subject to federal estate taxes and whose children are likely to owe estate taxes on their inherited money. If your goal is to preserve as much wealth as possible, you can have the funds transferred directly to your grandchildren, so your children won’t owe estate taxes.[iv] It’s important to note that GSTs are irrevocable, meaning that once money is transferred to the trust, it cannot be removed.
How to Create a Generation-Skipping Trust
A GST is a complex legal entity, requiring the help of an estate attorney to craft the precise legal language stipulating how and when the money is to be passed to your grandchildren. The money is held in an escrow account owned by the trust, which can only be released by the trust’s executor.[v]
While GSTs can be created inexpensively online, it’s highly recommended you work with a qualified financial professional with experience in drafting complex trusts.
Overall, using a GST can be a great strategy for those families worried about future estate taxes. Having one in place can make a sizeable difference in how much you are able to pass on and how easy it will be for your heirs to receive their inheritance.
SA Piggush Financial Consultants and LPL Financial do not provide legal advice or tax services. Please consult your legal advisor or tax advisor regarding your specific situation