An Introduction to Generation Skipping Trusts

by: Michael Mueller, Senior Financial Planner

January 10, 2024

Wealthy families can benefit from a variety of estate planning strategies that help preserve their family’s wealth for generations to come. A previously covered option was Intentionally Defective Grantor Trusts, available to read here. Another, explained in this article, is the Generation Skipping Trust (GST): an irrevocable trust that allows wealthy individuals to pass assets down to future generations by “skipping” one generation of estate tax.  

GSTs are a popular wealth preservation strategy, particularly during a time when the lifetime estate and gift tax exemption is historically high, as it is now. Individuals can establish a GST in a couple of different ways depending on their wishes for their heirs.  

In this introductory guide we will outline how generation skipping trust works and share some of the potential benefits and drawbacks for individuals to consider.  

What is Generation Skipping Transfer Tax (GSTT)? 

Generation skipping tax is a federal tax on a gift or inheritance by two or more generations below the grantor. This typically happens when a grandparent gifts assets to their grandchildren or great grandchildren. Generation skipping tax is separate, but in addition to, the federal estate tax.  

What is a Generation Skipping Trust? 

A GST is an irrevocable trust (entity) that enables grantors to have their assets skip a generation for estate tax purposes. This allows grandparents to skip a generation of tax (their children), avoiding their family’s wealth being subject to estate tax twice. Although the children’s generation is being “skipped” for estate tax purposes, they are still able to benefit from the assets being passed down to the grandchildren by having access to the income – and sometimes principal – of the assets that are placed in the GST. 

Implementing a Generation Skipping Trust (GST) 

The following two scenarios are further illustrated with the graphic below. 

Scenario 1 

John and Lisa – married – gift assets worth $27,000,000 to a GST and have their full lifetime exemption remaining. The direct beneficiary of the trust is their grandchild, Ryan. The trust stipulates that Ryan’s father, Tim (married to Lisa), can indirectly access income from the trust. Assuming John and Lisa live another 10 years, at the time of their passing the trust is worth approximately $48,500,000 using a 6% growth rate. This means that approximately $21,500,000 of appreciation is passed down to the direct beneficiary (third generation), Ryan, estate tax free. The trust can also be set up to continue – and not pay out all income and principal outright – for a longer period, thus continually benefiting the grandchildren and potential great-grandchildren.  

Scenario 2 

If John and Lisa had not implemented a GST trust, the entire $48,500,000 would be subject to estate tax at Tim’s death. Assuming Tim was married, and estate tax exemptions remain the same, only $39,900,000 would transfer to Ryan in this scenario. By implementing the GST trust, the family can preserve $8,600,000 in wealth! 

The above examples are simplified and do not consider spending withdrawals, different growth rates for assets in the estate, lifetime exemptions reducing by 50% in 2026 (which would further exacerbate the wealth preservation), etc. But the examples do exemplify the power of GSTs for wealth preservation.  

Benefits of Generation Skipping Trusts 

Much like any estate planning strategy, GSTs bring a range of benefits to families and individuals.  

Benefits of a Generation Skipping Trust 

The benefits of a GST include: 

  • Generational Wealth Preservation: a GST allows wealthy individuals to preserve their family’s wealth over multiple generations, providing benefits to both children and grandchildren while preventing the family’s assets from being subject to estate taxes twice.  
  • Asset Protection: as an irrevocable trust, any assets held within the trust are considered separate from the grantor’s personal estate and therefore are difficult to access in the event of any litigation against the grantor.  
  • Flexibility: GSTs can be set up so that both generations, the children and grandchildren, benefit.  

Smith + Howard Wealth Management: Experienced Estate Planning Advisors 

Generation skipping trusts can be a powerful estate planning tool for wealthy families looking to minimize the estate taxes they will pay over multiple generations. A GST provides individuals with a flexible tool that allows them to preserve their family’s wealth for generations to come, passing assets to their grandchildren while providing income to their children.  

A generation skipping trust is just one of many estate planning strategies available to high-net-worth individuals. At Smith + Howard Wealth Management, our experienced advisors take a comprehensive approach to helping individuals design the optimal estate planning strategy for their personal goals. We work closely with Smith + Howard’s tax practitioners to ensure a tax-efficient approach to estate planning that maximizes our clients’ wealth for generations to come. To learn more about our services, contact a Smith + Howard Wealth Management advisor today