Leaving a legacy for one’s family is a common estate planning goal. Many people with significant personal resources want to provide resources for their close family members. As a result, estate planning often prioritizes the need that a spouse or someone’s children would have for certain types of support.
However, many testators who have already enjoyed a successful professional life have no trouble ensuring that their spouses have adequate resources available to them after death. They may also have invested quite heavily in the careers in education of their children. As a result, these individuals might aspire to leave more for their grandchildren than their children. One of the tools people utilize for such goals is a generation-skipping trust.
There is a common misconception that a trust can effectively prevent tax liability. However, a generation-skipping trust can be subject to special estate taxes that other estates would not be responsible to pay.
Skipping a generation means enhanced tax risk
Someone who decides to fund a generation-skipping trust can set aside specific resources for their grandchildren so that their children won’t interfere in their inheritance. Resources left directly to minor grandchildren, for example, would end up in the control of their parents until they reached the age of majority. A parent could waste their child’s inheritance before they ever have access to it.
A generation-skipping trust helps ensure that only the trustee and the intended beneficiaries will have access to those inherited resources. However, there is a tax that applies when someone leaves assets for their grandchildren and not for their children. The exemptions for this tax mirrors the exemptions available for estate tax in general. In 2023, that exemption threshold is $12,920,000.
If a generation-skipping trust has more assets than that to pass to someone’s grandchildren, the federal government will assess and collect a tax that could be as high as 40%. That is the same as the maximum tax rate for general federal estate taxes. Grandparents seeking to leave a robust amount of support for their grandchildren may therefore need to make strategic gifts while they are still alive and use other estate planning tools to effectively minimize their tax risks.
Learning more about the financial challenges that are commonly associated with unique legacy wishes can help people preserve more wealth for their intended beneficiaries after they die.