GENERATION SKIPPING TRUST also known as a LEGACY or DYNASTY TRUST
Today, I want to talk about a term that is often misunderstood in estate planning: The Generation Skipping Trust. A generation skipping trust does not mean that the inheritance skips your children and only goes down to the grandchildren—that is the big misunderstanding with such a confusing name for the trust. A generation skipping trust is a trust that continues for the lifetime of the beneficiary, and longer. In some states (Hawaii is one of them) a generation skipping trust is allowed to continue forever. Such a trust is sometimes called a “Legacy Trust” or a “Dynasty Trust.” A generation skipping trust can give asset protection to the beneficiaries, such as children and grandchildren.
With an ordinary revocable living trust, when the parents die, the assets are distributed to the children (or other loved ones). For example, suppose that Mother has an ordinary revocable living trust. When she dies, the trust ends. All of the assets in the trust go to her Daughter. Daughter has a husband and two children. Later, the Daughter dies. All of the assets which Daughter inherited from her mother go to Daughter’s husband. Then Daughter’s husband remarries. When he dies, all of the inheritance which mother left for Daughter now goes to Daughter’s husband’s new wife! Daughter’s own children (mother’s Grandchildren) get nothing. The assets have gone outside of the family line to a stranger.
Instead of dying, suppose that Daughter gets a divorce. In the divorce, Daughter’s husband may try to get some of the inheritance which Daughter’s mother gave to her. If Daughter put her husband on title with her, then husband could get half of those assets in the divorce. Even if Daughter does not put husband’s name on the property, in the divorce, he may be able to get one-half of the appreciation of the property. For example, suppose that when Mother died, Daughter inherited mother’s house worth $300,000. Daughter keeps the house in Daughter’s name. Several years later she gets a divorce. At the time of the divorce, the house is now worth $500,000. Since the house was worth $300,000 when Daughter inherited it, in the divorce Daughter gets to keep $300,000 worth of the house. However, since the house has grown in value $200,000 during Daughter’s marriage, in the divorce, husband may be able to go after half of that $200,000.
Another problem that most people don’t think about is estate taxes, not when parents die, but when the children who inherit the property die. Suppose that daughter is 50 years old when she receives her inheritance from Mother. Suppose that the inheritance is worth $500,000. Daughter lives for 30 more years. At the time of her death, the $400,000 inheritance she received from her mother is worth millions. We do not even know what the estate tax laws will be 2 or 3 years from now, as we’re expecting the estate tax exemption to drop by 70% under the current administration’s plan. We have absolutely no idea what the estate tax laws may be 30 years from now. However, if there is an estate tax when Daughter dies 30 years from now, then the inheritance Mother gave Daughter will increase Daughter’s estate tax problems.
The generation skipping trust (or Legacy Trust) has these advantages: 1) If Daughter dies, the inheritance she received from Mother is guaranteed to go to Mother’s grandchildren, rather than to Daughter’s husband; 2) If Daughter gets divorced, her husband cannot take away the inheritance which Daughter received from Mother; 3) The assets in the generation skipping trust will not be taxed by the estate tax when Daughter dies; and 4) If designed properly, the assets in the generation skipping trust can be protected from lawsuits.
This is why the generation skipping trust is becoming popular. It gives asset protection to the person who inherits the assets.
This column is for general information only and is not tax or legal advice. The facts of your case may change the advice given. Do not rely on the information in this column without consulting an estate planning specialist.