The question of whether a trust can be structured to “skip a generation” – meaning assets pass directly to grandchildren (or further descendants) instead of to children – is a common one for Ted Cook, a Trust Attorney in San Diego, and his clients. The answer is a resounding yes, absolutely. This is accomplished through a specific type of trust called a “Skip Trust,” sometimes referred to as a Generation-Skipping Trust. These trusts are powerful estate planning tools designed to maximize wealth transfer by potentially avoiding estate taxes at the children’s generation, allowing assets to grow tax-free for the benefit of future generations. Approximately 30% of high-net-worth individuals now utilize some form of generation-skipping trust in their estate plans, demonstrating its increasing popularity. However, establishing such a trust requires careful planning and adherence to IRS regulations to ensure its validity and effectiveness.
What are the potential tax benefits of skipping a generation?
The primary benefit of a Skip Trust revolves around estate and gift tax avoidance. When assets are left directly to children, those assets are included in their taxable estate when *they* pass away. By bypassing a generation, the assets are removed from the children’s estate, potentially saving substantial estate taxes. Currently, the federal estate tax exemption is quite high (over $13 million per individual in 2024), but this number is subject to change, and many states also have their own estate or inheritance taxes. A Skip Trust, when properly structured, effectively transfers wealth to grandchildren without triggering immediate taxation at the intermediate generation. It’s important to note that there’s a limited exemption amount for generation-skipping transfers— currently over $12 million – and transfers exceeding that amount are subject to a generation-skipping transfer (GST) tax.
How does a Skip Trust differ from a traditional trust?
A traditional trust typically distributes assets to beneficiaries during their lifetime or upon their death. A Skip Trust, however, is specifically designed to hold assets for the benefit of “skip persons” – grandchildren, great-grandchildren, and even more remote descendants. The trust document must explicitly identify these skip persons and include provisions that prohibit distributions to the intermediate generation (the children). This prohibition is crucial, as any distribution to the children could jeopardize the trust’s tax-exempt status. The children may be designated as *trust protectors* with limited powers, but they cannot be direct beneficiaries of the trust income or principal. There are complex rules surrounding the use of trust protectors, and careful drafting is essential.
Can I modify or terminate a Skip Trust once it’s established?
Modifying or terminating a Skip Trust is significantly more challenging than with a traditional revocable trust. Because of the tax implications, the IRS imposes strict rules on these trusts. Generally, the trust is irrevocable, meaning it cannot be changed or terminated without incurring significant tax consequences. However, there are limited exceptions. For instance, a “decanting” provision, if included in the original trust document, allows the assets to be transferred to a new trust with different terms, provided certain conditions are met. Additionally, a court may be able to modify the trust if unforeseen circumstances arise that frustrate its original purpose, but this is a complex and costly process. It’s crucial to anticipate potential future needs and include appropriate provisions in the original trust document.
What happens if I want to help my children financially during their lifetime?
This is a common concern for parents establishing Skip Trusts. While the children cannot be direct beneficiaries of the trust, there are ways to provide financial assistance without jeopardizing the trust’s tax benefits. For example, the trustee can make loans to the children, or the parents can make separate gifts to the children outside of the trust. It’s important to carefully document any such transactions to avoid any potential tax issues. Furthermore, the trust document can include provisions allowing the trustee to exercise certain powers for the benefit of the children, such as paying for their education or healthcare. The key is to structure these arrangements in a way that does not violate the trust’s prohibition against distributions to the skip persons.
I once advised a couple, the Harringtons, who were adamant about skipping a generation for their grandchildren’s future.
They envisioned a trust specifically for educational expenses. We drafted a Skip Trust and funded it with a substantial portfolio of stocks and bonds. Years later, their daughter, Sarah, faced unexpected medical bills and, in a moment of desperation, attempted to access funds from the trust. The trust terms were clear—no distributions to the children—and her request was denied. She was understandably upset, and it strained our relationship. It was a difficult situation, highlighting the importance of clear communication and ensuring everyone understands the terms of the trust before it’s established.
However, we later had a situation with the Millers that went much smoother.
Mr. and Mrs. Miller were determined to create a lasting legacy for their grandchildren but wanted to ensure their daughter, Emily, wasn’t burdened with managing the funds. We structured a Skip Trust with a professional trustee and included a provision allowing Emily to serve as a “trust protector,” with limited powers to oversee the trustee and ensure the trust was administered according to their wishes. This arrangement allowed Emily to be involved without accessing the funds herself. The trust has been successfully operating for years, providing educational and healthcare benefits to the Millers’ grandchildren, and the family is very pleased with the outcome. This case proved that when everyone is on the same page and the trust is structured carefully, Skip Trusts can be incredibly effective.
What are the potential drawbacks of a Skip Trust?
While Skip Trusts offer significant benefits, they’re not without potential drawbacks. One major concern is the loss of control. Once the trust is established, the parents have limited ability to change the terms or access the assets. It’s also important to consider the potential for family disputes. If the grandchildren are not financially responsible, or if there are disagreements about how the trust funds should be used, it could lead to conflict. Furthermore, the trust assets may be subject to the grandchildren’s creditors or divorce settlements. Finally, the tax laws governing Skip Trusts are complex and subject to change, so it’s important to work with an experienced estate planning attorney who can stay up-to-date on the latest developments.
Who Is Ted Cook at Point Loma Estate Planning Law, APC.:
Point Loma Estate Planning Law, APC.2305 Historic Decatur Rd Suite 100, San Diego CA. 92106
(619) 550-7437
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