Heirs Not So Reliable? Consider Some Generation-skipping Strategies

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It’s a more common dilemma than you might think: A successful person has a substantial estate to pass down, but a member of the family’s next generation has proven to be a poor money manager. In other words, the owner’s own child or children might quickly squander a carefully accumulated inheritance.

But it’s still possible to design a trust that will benefit grandchildren, without letting their irresponsible parent or parents misuse assets that are meant to benefit the next generation.

We recently heard about a not-so-young man who has quit or been fired from a long sequence of jobs and has taken huge sums of money from his parents that he mostly spent on fun and games. Now divorced, he has been stingy with child support. His teenage children and their mother must rely on welfare just to get by! His own father, now elderly, has a sizeable estate. The older man’s challenge, now, is whether he can find a way to help his needy grandchildren. Or will he take the easiest option, and just leave his money to his son? A son who is sure to fritter it away, just as he’s done with all the other money his parents have given him over the years.

Unfortunately, we have run into this situation with several clients. And many factors can interfere with finding the best solution to the problem. First, sadly, most people lack the ability to see their way past their children’s wiles and to recognize that they should pass them by and let their estate go directly to the following generation.

And even those who recognize the problem may run into the problem of the so-called “generation skipping tax.” This is a little-known provision of federal tax law. It states that when you leave an inheritance that “skips” a generation — and heirs in that generation are still living — you will have to pay a tax. And that is a whopping 50 percent! That provision applies only to estates over $1 million, and with a larger inheritance, that first million is exempt, but estates of this size are quite common these days. So, it’s important to be aware of this provision.

On the other hand, if for any reason members of the next generation have died, then the grandchildren’s generation “steps up” and the tax doesn’t apply.

Our advice to anyone concerned about that big potential tax bite: don’t let the tail wag the dog. If you have good reason to believe your money would be squandered if you did leave it to your immediate offspring, you might as well secure it for the next generation, tax, or no tax.

Here’s one way we can help accomplish that goal and minimize the tax impact. We set up what is called a GST: a “generation skipping trust.” It contains no more than $1 million, so it’s not subject to the generation-skipping tax. And the sum is put in trust for the grandkids. If any funds are left over, then they can be put in trust for the unreliable child — the grandchildren’s parent. That trust is set up with very strict usage rules, governed by a trustee like Old North State Trust that will be sure to carry out the owner’s wishes.

One example of this is a client of ours who had two children, both of whom were drug addicts. As it happens, both these children have now died prematurely, so, unfortunately, the problem has taken care of itself. But the client’s trust had been set up so her children had to pass a drug test before they could get any money.

We have other family situations where drugs aren’t the problem, but the kid (and we use the term “kid” loosely) just wouldn’t work. So, in these cases, the trust’s terms provided that the child must provide us with a W2, proving he’s gainfully employed before he can get any money from the trust. Even then, the funds may be used only for certain things, such as medical expenses.

When considering your own estate options, you certainly can cut out anyone, and leave your assets to anyone else of your choosing. But in doing so, you should understand how best to accomplish your goals, and what the consequences will be. Nevertheless, whatever those consequences, it’s always better to do the choosing yourself. The alternative is to let the state decide, which almost never matches up with what a responsible person would have chosen for his or her family.





Old North State Trust, LLC (ONST) periodically produces publications as a service to clients and friends.  The information contained in these publications is intended to provide general information about issues related to trust, investment and estate related topics.  Readers should be aware that the facts may vary depending upon individual circumstances.  The information contained in these publications is intended solely for informational purposes, is proprietary to ONST and is not guaranteed to be accurate, complete or timely.