What Is a Generation-Skipping Trust (GST)?
A generation-skipping trust (GST) is a type of legally binding trust agreement in which the contributed assets are passed down to the grantor's grandchildren, thus "skipping" the next generation, the grantor's children. By passing over the grantor's children, the assets avoid the estate taxes—taxes on an individual's property upon his or her death—that would apply if the children directly inherited them.
Generation-skipping trusts are effective wealth-preservation tools for individuals with significant assets and savings.
- A generation-skipping trust (GST) is a legally binding agreement in which assets are passed down to the grantor's grandchildren—or anyone at least 37½ years younger—bypassing the next generation of the grantor's children.
- By skipping the opportunity to receive the assets, the children of the grantor avoid the estate taxes that would otherwise be due.
- Generation-skipping trusts are liable for taxation if the amount transferred exceeds a certain annually adjusted threshold ($11.7 million in 2021).
Understanding a Generation-Skipping Trust (GST)
Because a generation-skipping trust effectively transfers assets from the grantor's estate to 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 came into the possession of the next generation first.
Though grandchildren are the most common beneficiaries, 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 37½ years younger than the grantor and not a spouse or ex-spouse.
Generation-skipping trusts can still provide some financial benefits to the next generation because the grantor can give children access to any income the trust's assets generate while still leaving the assets themselves in trust for grandchildren.
Taxing the Generation-Skipping Transfer Trust (GST)
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. Generation-skipping transfer tax rates have risen and fallen over the years, with a recent high of 55% in 2001 and a low of 0% in 2010—due to an exemption awarded by the 2010 Tax Relief Act.
Intended to ensure that people transferring modest sums of wealth to younger generations don't have to bear the brunt of the tax burden, these exemptions were secured by the American Taxpayer Relief Act of 2012. This legislation established a permanent $5 million tax exemption on generation-skipping transfers, which meant the federal tax on a generation-skipping transfer of wealth would apply only if the amount exceeded $5 million.
However, the GSTT truly applies to the very wealthy because the transferred amount is astronomical. Most people will never encounter the GSTT because of the high threshold: the tax only applies when the transferred amount exceeds $11.4 million per individual (for 2019), and in 2021 is $11.7 million.
The generation-skipping tax exemption amount for 2021.
Increasing the Generation-Skipping Trust Tax Exemption
Even with the installment of taxes on generation-skipping transfers, GSTs still serve as tools for high-net-worth individuals to transfer wealth at a lower tax rate. And they became even sharper tools on Dec. 22, 2017, when President Donald Trump signed into effect the Tax Cuts and Jobs Act, which doubled the generation-skipping tax exemption.
Starting on Jan. 1, 2018, the Tax Cuts and Jobs Act (TCJA) doubled the estate tax exemption to $11.2 million for singles and $22.4 million for married couples, but only for 2018 through 2025. The exemption level is indexed for inflation. The 40% top tax rate remains in place.
This act expires on Jan 1, 2026, pushing the exemptions back to their pre-Act amounts unless Congress extends them.