Updated: January 5, 2023
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 the most common GST used. It is indirect in that there are intermediate steps, either:
The taxable termination indirect skip trust is the most common indirect GST and involves both skip and non-skip persons.
The Taxable Termination Trust is the most common GST. It is a testamentary trust created at your death that is first used to provide income and/or gifts to your children, the primary beneficiaries, before ownership is transferred to the skip person.
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.