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Generation-Skipping or Dynasty Trusts: Keeping Wealth in the Family for Decades To Come

For most people, estate planning serves one purpose: to have ones affairs in order before it’s too late. By providing for guardianship for their children, writing up advance directives for healthcare and creating a will or an estate plan, people can ensure that the state will have no say over who raises their children, that their wishes with regards to end-of-life medical procedures are known and that their estate will be distributed the way they think is best. But for the very wealthy there is another element to consider: taxes. This is where charitable remainder trusts, life insurance trusts and other irrevocable trusts that I have previously talked about come in handy.

For wealthy people who want to pass on significant assets to their grandchildren there is another such vehicle, the generation-skipping trust. With it, the grantor’s children, i.e. the second generation, may receive income from the trust, but the principal isn’t distributed until they have died and the third generation inherits. For those without children, these trusts can still be useful. In their case the beneficiary must be at least 37.5 years younger than the donor. And for those who like to think not just two but many more generations ahead, there is always the option of keeping the trust going for many decades: California allows a trust to last about 90 years, and many states have no rules against perpetuities.

Generation-skipping trusts, aka dynasty trusts, come with special tax rules: The assets in the trust are included in the grantor’s estate, which will be taxed if its value exceeds a certain limit. For the 2015 year, the exemption for the estate, generation-skipping transfer and gift tax is set at $5.43 million. (Just for clarification, this is a combined tax. If your estate is worth $3 million when you die and you have already put $2 million in a generation-skipping trust and donated $1 million to your favorite charitable institution, taxes will come due for the portion that exceeds the exemption, i.e. $0.57 million.)

The tax advantage of generation-skipping trusts can still be significant: When the grantor’s children die the property in the trust passes to the third generation tax free. Considering that the assets could appreciate significantly by then, the savings can be quite substantial. What’s more, the trust, like other irrevocable trusts, could be safe from the claims of creditors.

By Kevin J. Moore