Estate Planning is the process of creating a strategic plan that outlines how a person’s assets will be distributed after their death. These assets collectively form the individual’s estate. The ultimate distribution may be held in one of many various types of trusts. One such estate planning tool for high-net-worth individuals is the generation-skipping trust. This trust is specifically designed to transfer wealth from one generation to another while minimizing estate tax and generation-skipping transfer tax (GST tax).
Consulting with an experienced estate planning attorney will help you determine the best type of trust and estate plan suited to your unique situation. If you reside in Phoenix, Arizona, you can contact Copper State Planning at (480) 442-6413 for a consultation with one of their estate planning attorneys.
What Is a Generation-Skipping Trust?
A generation-skipping trust (GST trust) is a personal finance tool that allows a grantor to transfer money or other trust assets to a beneficiary who is at least 37.5 years younger than the grantor, bypassing immediate family members like children. The main advantage of this trust is to avoid multiple rounds of estate taxation by utilizing the lifetime tax exclusion Congress has granted us, thus preserving wealth for future generations by minimizing taxes.
Normally, wealthy estates have to pay estate taxes each time wealth is passed from one generation to the next. For example, an estate worth more than $13.61 million in 2024 is subject to federal estate tax. Additionally, 12 states and Washington, D.C., levy their estate taxes. While some might attempt to skip over their children and leave assets directly to grandchildren to avoid taxes, this triggers the generation-skipping transfer tax (GST/GSTT), an additional 40% tax. However, a properly crafted generation-skipping trust can help reduce both estate tax and GST tax liabilities.
In many cases, the skip person (the trust beneficiary) can be a grandchild, great-grandchildren, or any individual unrelated to the grantor, as long as they meet the age requirement. Note that a spouse cannot be the skip person in a generation-skipping trust.
Given the complexities of such trusts, it’s critical to work with an estate planning attorney to ensure that the trust complies with federal tax laws and effectively meets your estate planning goals.
Key Takeaways:
- Generation-skipping trusts help avoid paying estate tax on each generational transfer of wealth.
- Skip persons are typically grandchildren or younger individuals, but they don’t need to be related to the grantor.
- Generation-skipping trusts are irrevocable, meaning once funded, they cannot be changed.
- Expert estate planning attorneys are crucial in setting up a successful generation-skipping trust.
The Benefits of a Generation-Skipping Trust
The primary benefit of a generation-skipping trust is the ability to pass wealth to future generations while minimizing taxes. Under normal circumstances, an estate worth over $13.61 million would be taxed upon transfer to a child, and again when that child transfers the estate to their children and again at each generation. By using a generation-skipping trust, the estate is taxed only once, significantly reducing the overall tax burden.
It’s important to note that this trust doesn’t necessarily disinherit the skipped generation (such as children). Instead, the trust can provide income to multiple generations over several decades, allowing flexibility in how wealth is distributed. The distributions from the trust can be carefully structured to suit the needs of each generation.
How a Generation-Skipping Trust Works
A generation-skipping trust (GST) is an irrevocable trust that allows a grandparent or parent to transfer wealth directly to the next generation, such as grandchildren, avoiding a third application of gift & estate taxes. It can create a direct skip, bypassing the intermediate generation.
To avoid high tax liabilities, careful allocation of the lifetime exemption is crucial. In 2024, the individual GST exemption is $13.61 million. Any excess will incur a 40% GST tax. Trustees must file a tax return to report distributions and other tax obligations.
These trusts can be part of broader wealth management strategies, including dynasty trusts that extend for multiple generations. Taxable termination events whereby a skip person receives trust assets (or the right to receive), can trigger tax consequences, so working with an expert tax planner is essential to maximize benefits and minimize costs.
Proper planning ensures the trust is an efficient tool for passing wealth, avoiding probate, and reducing income tax liabilities for the next generation.
Taxes Minimized by Utilizing Generation-Skipping Trusts
A well-designed generation-skipping trust can help minimize three major types of taxes:
- Estate tax
- Gift tax
- Generation-skipping transfer tax (GST tax)
Estate Tax: Federal estate tax is applied to estates over the exemption amount, which is currently $13.61 million in 2024. Some states also have their own estate tax exemption levels and tax rates, so it’s important to account for state laws.
Gift Tax: The gift tax applies when someone gives away assets during their lifetime. Individuals are allowed to make tax-free gifts up to the annual exclusion of $18,000 per person per year. Anything beyond that counts toward the lifetime gift tax exemption, which is the same as the estate tax exemption.
Generation-Skipping Transfer Tax (GST Tax): The generation-skipping transfer tax is imposed on transfers to individuals who are 37.5 years younger than the transferor, either directly or through a trust. As of 2024, the GST tax exemption is $13.61 million for individuals and $27.22 million for a married couple. Any transfer exceeding these amounts is subject to an additional 40% GST tax.
How to Minimize Taxes for Recipients
When planning how to distribute your estate, it’s important to remember that the cost basis of gifted assets transfers to the recipient. Highly appreciated assets may incur substantial capital gains taxes for the recipient when sold. Alternatively, assets passed through an estate generally receive a step-up in basis which avoids capital gains taxes.
In short, careful consideration of which assets to gift and which to pass through your estate will minimize the tax impact for your heirs.
Creating a Generation-Skipping Trust
Setting up a generation-skipping trust is a complex process, requiring compliance with IRS regulations. Generation-skipping trusts must be irrevocable, and it’s essential to work with an experienced estate planning attorney to ensure that your trust achieves your financial and personal goals. In some cases, the grantor may be able to act as a fiduciary, managing the trust’s assets within specific guidelines.
It’s always better to create your generation-skipping trust sooner rather than later, allowing time to adjust your overall estate plan, including decisions about your last will and testament and provisions for a surviving spouse.
Consult an Estate Planning Attorney Today
A generation-skipping trust can be a powerful tool to minimize taxes and protect wealth for future generations. However, due to the complexities involved, it’s advisable to consult with an experienced estate planning attorney to ensure the trust is properly constructed and complies with tax laws. Residents in Phoenix, Arizona, can contact Copper State Planning at (480) 442-6413 to discuss their estate planning needs and learn more about the benefits of establishing a generation-skipping trust.
