Funding Your First Trust? What You Should Know About The Generation-Skipping Transfer

If you've recently begun giving some thought to your estate planning, you may be overwhelmed at the number of options available to you – from creating an irrevocable trust that will distribute assets to your heirs only upon your death to a more traditional will that sets out specific bequests for each of your children or grandchildren. Invariably, putting some forethought into these issues before drafting a will or trust will help avoid serious problems after your death, regardless of the size of your estate; however, estate planning is essential for those with substantial assets (and who wish to avoid losing a sizable portion of your estate to federal and state income taxes). Read on to learn more about some changes 2017 will bring to certain trust and estate issues, including changes to the generation-skipping transfer (GST). 

How are GSTs currently treated?

A generation-skipping transfer can be a gift or a transfer of the trust made from the benefactor to someone who is at least 37.5 years younger (or more than one generation younger) than the benefactor. There are several advantages to GSTs in trust and estate planning, from avoiding creditor claims against these assets to minimizing the amount of transfer taxes that will need to be paid. 

  • Claim avoidance

Assets held in trust for the benefit of a specific individual (or group of individuals) can sometimes be seized or garnished to help satisfy any outstanding judgments or liens. This means that if your child has a personal injury lawsuit pending against him or her, or has an outstanding child support obligation, tax lien, or other debt, any funds passed down through trust could be rightfully attacked by the creditor. In addition, those who go through divorce while (or after) they have been named the beneficiary of a trust could find themselves facing an expensive court battle with a soon-to-be ex-spouse who has made a claim on the trust as a marital asset. While GSTs don't provide a full inoculation against these types of financial messiness, the younger the beneficiaries, the less likely they are to have significant legal or personal entanglements that could cause trust funds to be forsaken.

  • Tax savings

Each time trust funds transfer from one beneficiary to another, there are costs associated with this process. Utilizing a GST to transfer to the generation directly below you will avoid the imposition of transfer fees and estate taxes – which, for estates in the seven and eight figures, can be substantial. 

What changes will 2017 bring to the GST tax? 

The federal government assesses a tax on generation-skipping trusts, although there is a fairly large exemption amount that will remain untaxed. While this tax was repealed on a nationwide basis in 2010, the law repealing it expired on December 31 of the same year, putting it back into play. 

Through the end of 2016, the GST exemption limit was $5.45 million. Trust transfers to an individual that total $5.45 million or less are tax-free; a tax rate of up to 40 percent will be assessed on any funds transferred in excess of $5.45 million. For 2017, this limit has been raised to $5.49 million. Although this may seem like a small increase, it does save an automatic $16,000 in taxes per beneficiary (assuming the amount between $5.45 and $5.49 million would have been taxed at the 40 percent rate). It's also important to note that this exclusion is on an individual basis – setting up your trust to make individual gifts to your grandchildren and their spouses (rather than larger gifts or bequests to couples) may be a way to quickly realize tax savings.

Talk to a trust management company for more information.