Generation Skipping Trusts: What They Are, How a GST Works

A generation-skipping trust (GST) allows people to leave assets to grandchildren or other people at least 37.5 years younger. Passing assets from Generation 1 to Generation 3 avoids paying federal estate taxes twice on assets — once when passing to Generation 2 and again when passing to Generation 3.

Although GSTs may avoid estate tax, they aren’t totally tax-free. Assets passing through a generation-skipping trust may be subject to the generation-skipping transfer tax. This tax rate happens to equal the estate tax rate, which ranges from 18% to 40%^[0]

» MORE: See our picks for the year's best will maker software

Generation-skipping trusts are best for higher net worth families that want to minimize taxes on their estate, says Diedre Braverman, managing attorney with Braverman Law Group in Boulder, Colorado. People who don’t have a will or estate plan may end up leaving their heirs with taxes that they could have avoided, she adds.

» Learn the difference: Wills vs. trusts

When considering if a GST works best for you, think of the following.

Advantages

• When set up properly, a GST may save money in taxes that Generation 2 may have had to pay had they received the assets first. This allows people to leave assets to grandchildren, nieces, nephews, grandnieces, grandnephews, or a younger spouse without having a lot of it swallowed up by taxes, Braverman says.<br>

• Trusts may be able to shield assets from lawsuits, bankruptcy and divorce settlements.<br>

• Setting up a GST gets you thinking about your legacy. “It may get you into estate planning in general,” Braverman says, “which is a good thing for everybody.”

» MORE: Retirement income planning: 4 steps to take now

Disadvantages

• Attorney fees associated with setting up a GST vary greatly across the country and can be hefty.

• Money in the trust can only be withdrawn for living expenses. While those amounts can be generous, it still has to have some relationship correlated to the beneficiaries’ standard of living, Braverman says.

• Trusts require a trustee, which is an ongoing expense.

• The generation that gets skipped may have objections. “Generation 2 can typically get income from the trust, but they don’t have ownership in the trust,” says Brian Hill, a partner at Ball Morse Lowe in Norman, Oklahoma. “They can’t sell the asset and go buy a bigger personal home. Because of that, there could be tension.”

» MORE: Why asset appraisals are key in estate plans

Work with an estate planning attorney to set up your GST. Some things to keep in mind:

1. Go slow. Setting up a GST involves at least three generations of people, so it’s essential to think through the process. “This is in place for a long time,” Hill says.

2. Talk to various advisors. Speaking with different people helps you think through all the different what-ifs, Hill says. Consider including tax professionals, financial planners and even other family members in your conversations.

3. Keep your appointment. People tend to cancel their appointments when they don’t have all the answers to questions that a lawyer may have sent them before their first meeting, Braverman says. This is a mistake. Working with a good attorney will help you get the answers you need.

4. Think about what you want your trust to encourage or discourage. Lawyers can put all kinds of provisions in trusts, Braverman says. Stipulations on substance abuse or GPAs or beneficiaries being self-supporting, for example, can help express the client’s overall intent. 

» See the differences: Revocable vs. irrevocable trusts

People often make two common mistakes, according to Braverman.

1. Naming family members as trustees. Money creates suspicions, and the trustee has a lot of power, she says. This can build resentment and cause problems.

2. Not considering who will be trustee if your original trustee passes. Consult with your attorney about who will take over if your original trustee can no longer handle the role. Braverman suggests three options for these successor trustees: Trust departments in large financial institutions, trust companies or professional, private fiduciaries.

» MORE: ​​Last will and testament: What it is, how to create one