Transferring your estate to your posterity after you pass on is not something the government wants to allow you to do for free. Heavy estate taxes are subtracted from your wealth when making these transfers, which is part of the purpose of using trusts. Normally, these will transfer property to your children, but not all trusts work that way. One type of trust called a generation-skipping trust, allows you to pass on your wealth while avoiding heavy estate taxes.
Why Skip a Generation?
A generation-skipping trust, instead of passing wealth on to your children, passes it on to your grandchildren. This serves the purpose of avoiding estate taxes that can still come into play when you use a regular trust. For example, when the trust amount is paid out to your beneficiaries, they may have to pay taxes on the amount received. When they pass that wealth on to their children, the tax amount is paid again when their beneficiaries receive it.
With a generation-skipping trust, you effectively avoid those taxes that would be incurred if your children were to inherit your wealth directly from you. Instead, it is passed on to your grandchildren, or rather, to beneficiaries who are at least 37.5 years younger than you are. That way, your children can still receive income from the trust as it appreciates, but you eliminate transfer taxes for them.
Along with reducing estate taxes, these trusts have other benefits as well. For example, you could put long-term appreciated assets into the trust in order to keep them from being sold too early by your children. If one of your children goes through a divorce or falls into debt, your assets will be kept safe from any attempts to seize them since they won’t actually belong to that child. It’s a method of long-term asset protection as well as estate planning.
Generation-Skipping Transfer Tax
There is one very minor complication when it comes to generation-skipping trusts, and that is the generation-skipping transfer tax. This tax takes any amount over a certain exemption amount and taxes a percentage of it when transferred.
Fortunately, the exemption amount is currently a little less than $5.5 million. Thus, if your generation-skipping trust remains below that amount, you won’t have transfer taxes to worry about on the trust. This is far preferable to the usual transfer amount, which is roughly $2 million.
While unlikely for most families, if the assets in the trust appreciate beyond the exemption amount, then generation-skipping transfer taxes will begin to apply. These can get as high as 40%, depending on the amount, and will therefore dramatically reduce the wealth that goes to your grandchildren.
Structuring the Trust
In order to function properly and keep your assets secure, generation-skipping trusts need to be properly structured. Various elements, such as the types of assets, how they appreciate, who the beneficiaries will be, and how tax laws operate, will need to be taken into account. An estate planning lawyer such as those at Hart & David can help you through the trust structuring process.