Last updated: September 26, 2022

What are the Advantages and Disadvantages of a Generation Skipping Trust?

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What are the Advantages and Disadvantages of a Generation Skipping Trust?

Before we can answer the question "What are the Advantages and Disadvantages of a Generation Skipping Trust," we first have to look at what a trust is, and how a generation skipping trust differs from a standard trust.

What is a Trust

A trust can be described as a collection of assets grouped together with certain stipulations that are maintained even after your passing.

These stipulations include things such as who inherits the assets within a trust, when they inherit it, and how. 

Usually this can be split into two categories; a lump sum, and intervals. It is greatly beneficial because it allows a large amount of control to remain in the hands of the person who is passing on their assets. There are a variety of different trusts that will suit certain situations better.

What are the Advantages and Disadvantages of a Generation Skipping Trust-Generation Skipping Trust

What is a Generation Skipping Trust?

A Generation Skipping Trust occurs when the person who creates the trust, also known as the trustor, skips over a generation and leaves their assets to the next one. Usually this occurs when people leave some of their assets to their grandchildren instead of their children, thus skipping a generation.

However, this does not always have to be the case. Depending on the specific country and state in which a person lives, the person might not have to be blood related at all, but instead only be a minimum of 37 ½ years younger than the trustor. This means that money could even be left to friends, or godchildren.

What are the Advantages and Disadvantages of a Generation Skipping Trust?

As with all things, there are both advantages and disadvantages of a generation skipping trust and it is important to understand both in order to know if a generation skipping trust will be beneficial to you, or if another option might be better.

What are the disadvantages of a generation skipping trust? 

What are the advantages of a generation skipping trust? The first advantage is the avoidance of taxes.

If a person was to leave their estate to their children, who pay an inheritance tax of as much as 40%, and then those children die and leave the money to their own children, additional inheritance tax would have to be paid, this way at least one round of inheritance tax would be avoided as long as the amount is low enough to avoid GST (Generation Skipping Tax).

What are the Advantages and Disadvantages of a Generation Skipping Trust- GST

Secondly, the children of the trustor could still benefit from any of the income that is produced by the assets in the trust for as long as the trust exists and is not yet distributed to the person or people set to inherit it. This could include properties being leased out and more, ensuring that both generations still benefit from the existence of the trust.

And lastly, because of the nature of a trust and the ability of a trustor to specify when and how the trustee receives their inheritance, they can to some degree prevent the trustee from using their inheritance recklessly or wasting it.

What are the disadvantages of a generation skipping trust?

First and foremost, it may have a large effect on those who are "skipped." In some cases multiple trusts can exist but if the income generated by the generation skipping trust is not high enough then those that are looked over, usually the trustor's children, will not benefit from this trust.

Additionally, there is a Generation Skipping Tax (GST) that may apply. Although, this is only true in cases where the value of the trust and the assets that it holds is determined to be above $12 Million as of 2022, so most families would be exempt from it. Still, it is important to take into account as the tax may be as high as 40%. This tax is intended to prevent great wealth transfer.

What are the Advantages and Disadvantages of a Generation Skipping Trust- Irrevocable Trust

Additionally, any sort of trust takes a large amount of planning and foresight to implement. However, not all trusts are irrevocable. A generation skipping trust is an  irrevocable trust like the generation skipping trust is a trust that can not be undone or altered once it is established, regardless of the circumstances.

Because of this, the generation skipping trust is particularly difficult to set up well as one has to account for future changes such as divorce, death, and more.

Who can Benefit from a Generation Skipping Trust?

Now that the question, "What are the Advantages and Disadvantages of a Generation Skipping Trust," has been answered, we can analyze whether or not a generation skipping trust would be suitable for you.

Firstly, considering the double taxation that may otherwise occur, we can assume that a generation skipping trust would be suitable for those who have larger estates, so that their children may still benefit from the income that is generated by some of the assets in the trust but the additional round of taxes may be avoided.

However, it is not suitable for those with an estate of more than about $12 Million. It is important to keep in mind that the assets within the trust might inflate and push the trust over the GST threshold before the threshold can be adjusted to meet inflation, in which case there would be almost no point to the tax.

So caution is advised for larger estates that contain large amounts of non-cash assets.

Additionally, it might not be the best option for those with smaller amounts of wealth that they wish to pass on. In cases like this, your children will not be able to benefit at all from the trust, and it might be better to simply pass on all assets directly to your children.

Regardless of whether or not you believe that a Generation Skipping Trust is right for you, it is always important to consult a financial advisor that is educated on the specific trust and tax laws of your region before making your decision.

This will ensure that your wealth, and that of your descendants is maximized, while at the same time making sure that all legal and tax obligations are understood and therefore kept.

You might be also curious about Spendthrift Trust Pros and Cons and What is Trust Decanting?


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