What is a 'Generation-Skipping Trust'

A generation-skipping trust is a type of legally binding trust agreement in which the contributed assets are passed down to the grantor's grandchildren, not the grantor's children. The generation the grantor's children belong to skips the opportunity to receive the assets to avoid the estate taxes -- taxes on an individual's right to transfer property upon his or her death -- that would apply if the assets were transferred to them.

BREAKING DOWN 'Generation-Skipping Trust'

Because a generation-skipping trust effectively transfers assets from the grantor's estate to his or her grandchildren, the grantor's children never take title to the assets. This is what allows the grantor to avoid the estate taxes that would apply if the assets were transferred to his children first. The recipient of a generation-skipping transfer doesn't necessarily have to be a family member. The beneficiary can be anybody who is at least 37 1/2 years younger than the grantor and not a spouse or ex-spouse. Generation-skipping trusts are effective wealth-preservation tools for individuals with significant assets and savings. Estate taxes in the U.S. in 2017 ranged from 18 to 40 percent, depending on the amount of wealth being transferred. 

Generation-skipping trusts can still provide some financial benefits to a grantor's children because the grantor can give his or her children access to any income the trust's assets generate while still leaving the assets in trust for his or her grandchildren.

Generation-Skipping Transfer Trust and Taxes and Tax Exemptions

Due to the generation-skipping trust's viability as a loophole to avoid federal estate taxes, changes were made to the tax code in 1986 that created a generation-skipping transfer tax. Tax exemptions, which were initially given through the 2010 Tax Relief Act then secured by the American Taxpayer Relief Act of 2012, ensure that people transferring modest sums of wealth to younger generations don't have to bear the brunt of the tax burden. The American Taxpayer Relief Act of 2012 established a permanent $5 million tax exemption on generation-skipping transfers, which meant there was only a federal tax on a generation-skipping transfer of wealth if the amount of wealth exceeded $5 million. This amount adjusts to account for inflation. The generation-skipping transfer tax exemption increased from $5.43 million in 2015 to $5.45 million in 2016. It rose to $5.49 million in 2017.

On Dec. 22, 2017, President Donald Trump signed the new Tax Cuts and Jobs Act, doubling the generation-skipping tax exemption. Starting on Jan. 1, 2018, individuals could exempt up to $11.2 million and couples could exempt $22.4 million. Like before, these amounts will increase to compensate for inflation on a yearly basis. This act expires on Jan 1, 2026, pushing the exemptions back to their pre-Act amounts unless Congress extends them. 

Generation-skipping transfer tax rates have risen and fallen over the years, with a recent high of 55 percent in 2001 and a low of 0% percent in 2010. Even with the installment of taxes on generation-skipping transfers, they still serve as tools for high-net-worth individuals to transfer wealth at a lower tax rate.

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