In order to understand the value of a generation-skipping trust for estate planning purposes, you have to digest some information about the federal estate tax. It carries an eye catching 40 percent maximum rate, so it can take a sizable chunk out of your legacy.
The vast majority of people do not have to be concerned about this death tax, because a certain amount of property can be transferred before the tax would kick in. This dividing line is called the credit or exclusion, and during the current calendar year, it stands at $11.58 million.
Every year, there can be adjustments to account for inflation, so you will probably see a somewhat higher figure when 2021 rolls around.
There is a marital deduction that can be used to transfer unlimited assets to your spouse free of taxation. One caveat to this statement would be that the marital deduction is only available to citizens of the United States.
The estate tax exclusion has been portable since 2011. This means that a surviving spouse could use the exclusion that their deceased spouse was allotted. The survivor would have their own exclusion, so there would be two exclusions that could be used.
Some states have state-level estate taxes, and the exclusions are usually lower than the federal estate tax exclusion. For this reason, you could be exposed to a state-level estate tax even if your assets do not exceed the $11.58 million figure that holds sway on the federal level.
We do not have a state estate tax in California. However, if you own property in a state that does have an estate tax (like Hawaii), the tax could be a factor for you.
Certain types of irrevocable trusts are used by high net worth individuals that have estate tax concerns. Since this type of trust cannot be revoked, you surrender incidents of ownership when you convey resources into an irrevocable trust. They are no longer part of your estate for tax purposes.
One of the trusts that can be useful under these circumstances is a generation-skipping trust. As the name would indicate, you would skip a generation when you are naming the beneficiaries.
Your grandchildren would typically be the beneficiaries, but under the law, anyone that is at least 37.5 years younger than you can be the beneficiary or “skip person.”
While your children are still living, the principal would remain in the trust. If you allow for it in the trust declaration, the children could receive income that is generated by the trust throughout their lives. These distributions would not be subject to the estate tax.
After the death of your children, the grandchildren would assume ownership of assets in the generation-skipping trust. This transfer would be subject to the generation-skipping transfer tax, which exists to serve the same purpose as the estate tax.
The benefit lies in the fact that two generations were able to benefit from the assets in the trust, but there was just one round of taxation. If you left the assets to your children, the estate tax would apply, and then it would be applied again when they were transferring the resources to your grandchildren.
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