Income from a generation-skipping trust (GST) can go to the grantor's children (the skipped generation) for their support and benefit, even while the principal remains protected, or directly to the "skip" beneficiaries (grandchildren, great-grandchildren, or younger non-relatives). The trust document dictates who receives income, often allowing children to access income while protecting the principal from their creditors or divorce, with ultimate distribution to grandchildren to avoid estate tax.
The GST tax is paid by the grantor if using the direct generation skip strategy, or the beneficiary if using the generation-skipping transfer strategy. Keep in mind that the tax only applies to assets above the lifetime exemption amount ($13.99 per individual in 2025).
In effect, trust fund distributions are assets or income that get passed from the trust to the beneficiary, or beneficiaries. Trust distributions are governed by the specific terms and directives of the trust. For example, some trusts require assets to be distributed outright to beneficiaries in a lump sum.
A generation skipping trust is a powerful estate planning tool, especially for individuals with large estates. They are a great way to help your family avoid paying estate taxes twice, when the estate passes to your children, and then again to your grandchildren.
A generation-skipping trust (GST) is a legally binding agreement in which assets are passed down to the grantor's grandchildren or anyone who's at least 37½ years younger, effectively bypassing the next generation of the grantor's children.
A dynasty trust, or perpetual trust, is a type of trust that is designed to pass on wealth from generation to generation in a tax-advantaged environment. Families can avoid being subject to gift tax, estate tax, and generation-skipping transfer tax as long as the assets remain in the trust.
Beneficiaries of a trust typically pay taxes on distributions they receive from the trust's income. However, they are not subject to taxes on distributions from the trust's principal.
In order to avoid the generation-skipping transfer tax on the initial transfer, an individual must use (allocate) some or all of one's GSTT exemption. The GSTT exemption may be used for both outright transfers as well as transfers in trust.
However, there is a little-known IHT loophole that does not have a set limit or post-gift survival requirement, known as 'Gifts for the Maintenance of Family'. Any gift that qualifies under this loophole is exempt from IHT. If HMRC decide that the gift was larger than reasonable, the reasonable part is still exempt.
If you receive some income from either a trust or from the estate of a deceased person, you may have further tax to pay on the income or you may be able to claim a tax refund. In some cases, you are taxable on trust income even if you do not receive it, but you can follow the guidance below as if you had received it.
Disadvantages: Implementation challenges, initial compliance costs, and potential inflation in some sectors. It may also burden small businesses with complex tax filings.
Grandchildren are the most common beneficiaries of this trust, but the recipient can be anyone more than one generation younger than the grantor, provided they are not a spouse or ex-spouse. The generation-skipping trust is irrevocable, meaning you typically can't change or modify it.
The 7-3-2 rule is a financial strategy for wealth building, suggesting it takes 7 years to save your first major financial goal (like a crore), then accelerating to achieve the next goal in 3 years, and the third goal in just 2 years, leveraging compounding and disciplined, increased investments (like a 10% annual SIP hike). It highlights how returns compound faster over time, drastically reducing the time needed for subsequent wealth targets, emphasizing patience and consistent, growing contributions.
The "7-year inheritance rule" (primarily a UK concept) means gifts you give away become exempt from Inheritance Tax (IHT) if you live for seven years or more after making the gift; if you die within that time, the gift may be taxed, often with a reduced rate (taper relief) applied if you die between years 3 and 7, but at the full 40% if you die within 3 years, helping people reduce their estate's taxable value by giving assets away earlier.
One of the biggest disadvantages of a Generation-Skipping Trust is the fact that they are considered Irrevocable Trusts. This means you do not have the power to amend or cancel them. The assets contained within the Trust will also no longer be under your control, and will instead be administered by a Trustee.
Give more money away
Lifetime gifting is a straightforward way to begin reducing your IHT bill. By gifting money during lifetime, that would have been part of an inheritance anyway, you reduce the size of your estate so that there is smaller amount subject to IHT on your death.
If you receive principal (the original assets placed in the trust), generally it's not taxable. If you receive income generated by the original assets (like interest, dividends, or rent) and it is reported on Schedule K-1, it is taxable to you and must be reported on your return using the Schedule K-1 from the trust.
It can be advantageous to put most or all of your bank accounts into your trust, especially if you want to streamline estate administration, maintain privacy, and ensure assets are distributed according to your wishes.