Updated: February 2, 2024
A generation-skipping trust (GST) is a type of irrevocable bypass trust for assets to be subsequently passed on to your grandchildren while avoiding or skipping estate taxes during your children’s generation. They can be a living or testamentary trust. GSTs are much more complicated than they seem and you will likely need a professional to create one.
A GST lets you transfer assets over the federal and/or state limits to beneficiaries at least two generations removed from you (skip person), and avoid estate taxes during the middle generation. This is called a generation-skipping tax or generation-skipping transfer tax.
Like any trust, you will name a trustee and can determine how, when, and why the funds are given to your children and/or grandchildren or leave it up to the discretion of your trustee. Your child could be the trustee.
Because of the time frame involved, there is a much higher chance of things changing or going wrong. A GST will require more thought and outside assistance than single generation trusts.
The generation-skipping tax differs from other estate taxes when over the limit. Rather than a variable taxation rate from 18% to 40% for the first $1,000,000 over the limit, the entire amount is taxed at 40%. However, since the GST avoided estate tax during your children’s generation, the overall result is less taxes.
There are two ways to transfer assets from your estate to your grandchildren or other “skip persons,” the indirect and direct skip.
The indirect skip is a testamentary trust created at your death, is the most common GST used, and involves both skip and non-skip persons.
Although your children benefit from the GST assets, they do not own them and are not part of their taxable estate.
If your child has died before you, your grandchild will take their parent’s place and would not have ownership but be able to pass on the trust to their children (your great-grandchildren) tax-free. For other provisions see the Predeceased Ancestor Rule.
The skip person can also receive gifts from this trust before they inherit the assets.
The skip person only inherits the assets after the death of the primary beneficiaries.
There are two types of trusts that transfer assets directly to your grandchildren, the only difference is when you can transfer them.
1. The Taxable Termination Trust is typically a testamentary trust created for your grandchildren/skip person.
The federal generation-skipping transfer tax applies when the assets are inherited by the direct skip person. The taxable amount is any inheritance over your unused federal estate tax exemption limit ($13,610,000 in 2024).
The lifetime gift exemption is automatically applied and you do not have to file an IRS Form 709, the U.S. Gift (and Generation-Skipping Transfer) Tax Return.
2. The alternative is a Taxable Distribution Trust, which is a living GST created while you are alive from which you can distribute gifts in the form of income or property to your grandchildren or other skip persons.
A private annuity trust can also be used as a type of generation-skipping trust.