Generation Skipping Trust

Generation Skipping Trust He sits in his study, surrounded by the trappings of wealth acquired by a lifetime of hard work, musing about his successes; successes that have allowed him to build a very lucrative business, raise and educate his children, and now offer him time to enjoy his grandchildren.

Yet, he worries about the future; not his, but the future of his family. His lawyer told him his estate is in order, the living trust in place, and that he has a bypass trust that ensures at least $2 Million will be passed to his kids, tax free, on his death and at the death of his wife.

That isn't what bothers him; rather, it is the nagging thought of the saying he heard a while back: "The first generation makes it, the second generation manages it, and the third generation spends it." That is not what he intended for his legacy!

A Generation Skipping Trust (GST) provides a unique estate planning opportunity for those like him who have accumulated wealth and wish to see it passed to future generations. A GST, properly funded, can reduce estate taxation and solve a variety of wealth transfer problems. Typically, wealth transferred between generations is subject to estate taxation of up to 46% at each transfer. However, by skipping over the first generation and leaving wealth to the second generation, the transfers are taxed once instead of twice.

In his case, he wishes to skip over his children and leave a portion of his sizable estate to his grandchildren.

At a 46% tax rate, a total tax of 70% on a grandparent's wealth would be paid by the time it gets to the second generation. However, a special part of the tax code allows grandparents to skip the first generation with up to $2 million per grandparent, and leave it to the second generation, paying the estate or gift tax only once.

He and his wife can each set aside $2 million in trust for the second generation. If set up properly, the trust can allow the first generation to have income from the property while they live. At the death of the income beneficiary the principal passes to the next generation.

This type of planning solves a variety of other planning problems as well. First, consider the case of the first generation children who do not handle wealth well. A grandparent can give the children rights to income only from the trust and leave the principal to the grandchildren. This ensures that the first generation will not squander the family fortune.

Perhaps of greater concern to grandparents is the risk that a son/daughter-in-law may end up with the family money through divorce or death of the child, remarry, and pass the family wealth outside the direct bloodlines. Again, by providing an income-only interest, this can be avoided. If the first generation children are involved in business activities that carry a high risk of creditor claims, or they are asked to sign personal guarantees for banks or other lenders, a Generation Skipping Trust provides an ideal solution for protecting family wealth from these claims. While generation skipping provisions are usually written into most living trusts, typically, funding does not take place until the death of the grandparents.

Our grandfather can create a real family dynasty of wealth if he acts to fund the trust before his and his wife's deaths. By setting up the trust and funding it with a life insurance policy on their joint lives, the parents can leverage the $4 million by ten times or more.

The money from the life insurance is all tax-free: The income earned from the proceeds may be used to benefit first generation children, and remain free from creditors or a disaffected spouse. Doing so, he has provided for the management of his legacy into the future generations and has minimized the amount of his hard work that could be paid to 250 million strangers through the estate tax system.