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How Does a Generation-Skipping Trust Work?

Generation-skipping trusts allow assets to grow or be transferred tax-free

By , Caring.com senior editor
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Generation-skipping trusts aren't just for the very wealthy -- they're a way to save any family's assets from excessive taxation, ex-spouses looking for money, and creditors. Plus, they protect assets such as stocks that are likely to grow in value over time.

What's the benefit to a generation-skipping trust?

Generation-skipping trusts are a good way for wealthy families to transfer assets from the senior generation to their grandchildren and great-grandchildren without exposing those assets to several levels of estate taxes. Typically, if the second generation in a family is already comfortable financially, the grandparents set up a generation-skipping trust providing for all of their descendants as possible beneficiaries. Ultimately, any remaining assets will be distributed to grandchildren or great-grandchildren many decades in the future. This way, all of the descendants (children, grandchildren, and great-grandchildren) can benefit from the trust assets, but the grandchildren or great-grandchildren eventually receive the remaining funds without the imposition of estate taxes when the children die, and again when the grandchildren die.

Not just for the wealthy

Let's say a child in the second generation goes through a nasty divorce. The divorcing spouse can't lay claim to a share of the assets in the trust, because they legally don't belong to the ex-spouse. They're for the benefit of the entire group of descendants of the grandparents. Likewise, if a child funds a start-up company and provides personal guaranties and the company drowns in debt, the trust assets can't be directly tapped to pay the debts, because the child doesn't own those assets.

The assets would also be protected in the event of other financial catastrophes, such as large gambling debts or an uninsured car accident. "A creditor could get a judgment against the child, but they can't go directly after the assets in the trust, because they wouldn't be his or her assets," attorney Philip Feldman says.

Likewise, if the grandparents fear that one of their children is a spendthrift and would waste his inheritance quickly, a generation-skipping trust allows the child to have access to the trust assets but not necessarily direct control over the amount or timing of distributions.