If you have heard of generation-skipping trusts (GSTs) at all, you probably think of them as a way for wealthy families to shield their fortune from estate taxes. That is true as far as it goes, but GSTs can also have benefits for the less well off by protecting assets from ex-spouses and creditors and by serving as a place for appreciable assets to grow outside of taxable estates.
Although the phrase “generation skipping” sounds like an arrangement which leaves out children altogether in favor of the grandchildren, in fact what a GST “skips” is the taxation of assets put into children’s estates by their parents. In a typical scenario, grandparents who are satisfied that their children are financially secure may decide to set up a GST in favor of all of their descendants as possible beneficiaries. Successive generations eventually receive the assets without the repeated imposition of estate taxes when each preceding generation dies. The assets are taxed only once, at the time of the initial transfer to the trust.
The first generation of children can be made to benefit as well. Although they technically won’t own the assets in the trust, they can be given a right to distributions for their reasonable needs, meaning not only their support and maintenance, but also “comforts, conveniences, pleasures, and happiness.” However, discretion over whether trust funds may be used for the benefit of the child must be exercised not by the child, but by a “disinterested trustee,” that is, someone who is not a related or subordinated person as defined in the Internal Revenue Code.
There is a limit on the amount that can be transferred into a GST. Currently, the limit is $2 million for each person setting up the trust. In other words, a married couple could place up to $4 million in a GST. In 2009, the per-person amount is set to rise to $3.5 million. Any amount that is transferred in excess of the limit is subject to gift or estate tax when the older generation passes along the assets, and an additional “generation-skipping tax” is imposed when the children die and the property is transferred to the grandchildren. The potential estate tax benefits of a GST are easy to see when it is considered that each dollar over the limit is taxed at the highest estate tax rate, which currently is 45%.
If there are downsides to a GST for some people, they may be found in the fact that someone outside the family (the trustee) will become intimately involved in the family’s money matters, and that it will be necessary to file an income tax return for the trust each year. Still, under the right circumstances and with proper planning under the guidance of a professional, these and any other drawbacks for a GST could pale next to the bottom-line advantages realized as assets are passed from generation to generation without Uncle Sam taking his cut.