A Simpler, More Flexible Approach to GST Planning

Estate Planner Jan-Feb 1998

Many people understand the tax advantages of creating generation-skipping trusts that benefit grandchildren and make use of the $1 million exemption from generation-skipping transfer (GST) tax. Yet not everyone who would benefit from this type of planning is willing to undertake it. Why? Perhaps they:

  • Don’t have any grandchildren yet.
  • Have some children who have a more immediate need for the funds who would not benefit from having their inheritances tied up in generation-skipping trusts.
  • Think revising an existing estate plan would be too complex or expensive.

In planning to take advantage of the $1 million GST tax exemption, the goal is to have assets pass from grandparent to grandchild without being taxed in the child’s estate.

Generation-skipping trusts limit the children’s access to the funds to avoid taxation in the children’s estates. A simpler approach to GST planning, however, also allows more flexibility.

Back to Basics: A Case Study

Tom has an estate of $2 million that he plans to leave to his children, Susan and Sarah. Susan owns a successful business and has a large estate of her own. Sarah is a struggling actress and has few assets.

In his estate plan, Tom provides that his estate be divided equally between Susan and Sarah with their shares held in separate trusts for their benefit. Each child will have the right to receive all the income from her trust and as much trust principal as is necessary for her support. Knowing that Susan is financially secure and Sarah needs funds, Tom gives them each a general power of appointment: the right either to withdraw all funds from her trust or to direct the trustee to distribute the principal of the trust to any person, including herself. The general power of appointment, however, will cause the trust to be subject to tax in the child’s estate.

Because Susan has a substantial estate that will be subject to estate tax on her death, she wants to ensure that as much as possible passes to her children tax-free. To do this, on her father’s death she disclaims the general power of appointment while retaining the right to receive income and principal from her trust. By so doing,she converts her trust into a generation-skipping trust for the benefit of her children. At Susan’s death, her children will receive the proceeds of the trust tax-free.

Sarah is not concerned about GST tax because she has no children and her estate likely won’t be subject to estate tax. On her father’s death she exercises her general power of appointment to take the principal of her trust outright. At Sarah’s death, any portion of the trust estate that she did not use during her lifetime will be included in her estate and, if her estate is large enough, will be subject to estate tax.

Make GST Planning Easy

Generation-skipping trusts can offer additional advantages, but the disclaimer method allows you to provide for your children equally, leaving the decision to implement GST planning up to each child. This method also gives your children the option to disclaim their general powers of appointment over a portion of trust assets rather than over all trust assets. This provides your children with the flexibility to use part of their inheritances for GST planning and retain part for their own use. Consequently, your children may be more inclined to take advantage of GST planning.

We would be pleased to tell you more about these trusts and to help you make GST planning work for you and your heirs.

4 Disclaimer Method Pitfalls

Although the disclaimer approach simplifies GST planning, you need to consider additional issues, including the following four potential pitfalls:

1. Your child may not be able to deal emotionally with these complex decisions within nine months after your death, as is required for the disclaimer to be valid.

2. Your child may be incapacitated and unable to make a valid disclaimer.

3. Your child may have creditor problems and the state where the child resides may not allow him or her to disclaim assets that would otherwise be available for creditors.

4. Your executor or administrator may not be capable of handling the complexity the children’s disclaimers and GST allocations would add to administration of the estate.