The term generation-skipping trust refers to an agreement in which the assets placed in a trust are passed to the grandchildren of the settlor, not their children. Generation-skipping trusts provide wealthy families with a way to lower estate taxes.
As is the case with other types of trusts, a generation-skipping trust would have a donor / settlor, trustee, assets, and a beneficiary. The donor / settlor would place assets into the trust, which would be managed by the trustee. The assets in the trust would then supply a beneficiary with a source of income.
A donor that would like to leave assets to their heirs has the option of establishing a trust for their children. However, if their children are wealthy and the assets in their trust are passed onto their children, the donor's assets can be subject to estate taxes on two occasions. For example, if the assets were first passed to the children of the donor, they would be subject to estate taxes. If the assets were eventually passed to children of the children (the donor's grandchildren), then they would be subject to estate taxes a second time.
GSTs minimize estate taxes by providing assets directly to grandchildren. Generation-skipping trust can also be used to protect assets from lawsuits, medical bills, divorces, bankruptcy, and children that are financially irresponsible. The federal tax code limit on tax-free withdrawals from a GST is $2.0 million.