Also known As a Generation-Skipping Trust

Ethan R. Okura
Hawai‘i Herald Columnist

Last month I provided an introduction to the dynasty trust (also known as legacy trust or generation-skipping trust) in this column. This month, I’ll go into greater detail about some of the advantages and disadvantages of the dynasty trust with as much insight as I can provide for my final Hawai‘i Herald column, with gratitude in my heart for all of the staff, as well as all of you fine and loyal readers.


This will explain in more detail the potential advantages and disadvantages of generation-skipping trusts, a trust that continues on for one or more generations after your death. It does not “skip” a generation in inheritance (in other words, it does not disinherit your children and leave everything to the grandchildren). The odd name is just short for Generation-Skipping Transfer Tax Exempt Trust.

Advantages of a Generation-Skipping Trust

  1. Children may be given the freedom to spend any amount or all of the trust income and principal, as needed, for the health, support in reasonable comfort and education of themselves or their descendants. If the children need to spend up all of the trust assets for their own support, nothing need be left to the next generation.
  2. Generation-skipping trust assets are not subject to the estate tax. Without a generation-skipping trust, inheritance from parents become assets of the children, so that when the children pass away, those assets are subject to federal estate tax. If any child saves, invests and at any time has sufficient assets to be taxed by the estate tax, then all of the inheritance received from parents will increase the amount of estate tax at the child’s death. On the other hand, in a generation-skipping trust, those assets are not subject to estate tax when the child dies, no matter how large those assets grow.
  3. The generation-skipping trust can guarantee that assets will stay in the family. Without one, a child might inherit assets from a parent, die, and then have those assets go to a surviving spouse. The surviving spouse of the child could remarry and leave those assets to a new spouse, with your assets potentially going to a stranger rather than your own grandchildren. With a generation-skipping trust, the child has full use and control of the assets, yet when the child dies, none of it goes to a surviving spouse, because the child does not own the assets. The assets can be guaranteed to go to your own grandchildren.
  4. Assets can be protected from divorce. Without a generation-skipping trust, if your child gets a divorce, it is possible their spouse could go after some of those assets. In Hawai‘i, if you leave an inheritance to your married child, and if that child gets a divorce several years later, then the inherited assets’s appreciated value can be subject to the divorce proceedings. On the other hand, with the generation-skipping trust, the trust assets do not belong to your child, and, therefore, are not typically subject to divorce proceedings.
  5. A generation-skipping trust may offer asset protection from creditors. If you were to leave an inheritance to your child outright, and if your child were sued and a judgment were obtained against your child, a judgment creditor could go after those assets. On the other hand, with a generation-skipping trust, there is a possibility that the trust would protect the assets from creditors. When the trustee of the generation-skipping trust is someone other than your child, or when there are more than one trustee, if your child is sued, your child could argue at court that they do not have the power alone to take assets out of the trust, and that the judgment creditor should not be able to reach those assets. If your child is the sole trustee of the trust and also a beneficiary, then the judgment creditor could possibly argue that since the child can take money out of the trust at any time, the court should order the child to take some money out to pay the judgment. Nevertheless, with a generation-skipping trust, there is certainly a better possibility of protecting assets from judgments, creditors and bankruptcy than there would be without one.

Disadvantages of a Generation-Skipping Trust

  1. Separate income tax returns must be filed. From the time of your death, when a generation-skipping trust becomes irrevocable, the trustee of the trust would generally have to file a separate tax return for the trust every year the trust earns income. Therefore, your child would have to file both a personal income tax return and a fiduciary income tax return for the trust income. However, we can also structure the separate trust for each child, so that a separate Tax ID number (TIN/EIN) and a separate tax return is not required. This would expose the taxable income of the trust each year to potential creditor claims, but it does not require any of the income to be distributed from the trust in order to take advantage of a potentially lower tax bracket for the beneficiary/child, and it is simpler by letting the beneficiary claim all of the trust’s income, expenses, credits and deductions on the beneficiary’s personal income tax return.
  2. It may be difficult to mortgage property owned by the trust after it becomes irrevocable. As other trusts, a generation-skipping trust becomes irrevocable, either upon creation as an irrevocable trust, or in the case of revocable living trusts, upon the death of the settlor. Most financial institutions do not like to make mortgage loans secured by real estate owned by an irrevocable trust, unless the trust generates a lot of consistent income. Therefore, you should not expect to be able to borrow money using property in an irrevocable generation-skipping trust as collateral.
  3. Your child’s descendants could complain that your child is spending more of the assets than is needed for your child’s health, support in reasonable comfort and education. As a trustee-beneficiary, your child can spend whatever amounts are necessary for his or her health, support in reasonable comfort or education. The IRS does not police your child to see how much is spent for support. Nevertheless, in the unlikely event that one of your children has such children who complain that your child is spending too much, the problem can usually be solved in either of two ways: (i) by having an independent (unrelated) trustee with full discretion over distributions; or (ii) by putting in the trust instrument a “special power of appointment.”

Special Power of Appointment

A special power of appointment is a power that you can give to your child (or any beneficiary) to cause the trust assets to be distributed upon your child’s death as your child directs in your child’s will. If your child does not exercise the special power of appointment, then upon your child’s death, the trust assets would go equally, in trust, to your child’s children, or if none, then, in trust, to your child’s siblings, if any. However, by exercising the special power of appointment, your child could cause the trust assets to go to someone other than his or her own child. The threat of using that power will probably discourage your child’s children from claiming that their own parent is spending too much trust money.

The special power of appointment can be designed to give your child the power to leave the trust assets to anyone in the world other than your child’s creditors, estate or creditors of your child’s estate. That would mean that the child could leave your assets to your child’s surviving spouse, friend, a charity or anyone else. I generally prefer limiting the special power of appointment so that your child can leave the assets in any proportion to any of your descendants, other than your child’s creditors, estate or creditors of your child’s estate. Under this limited special power of appointment, your child would be able to leave the trust assets remaining upon their death to only one of his or her children, instead of equally to all of them, or could give different percentages to each of them, or your child could leave the trust assets to a brother or sister or niece or nephew of your child, if any. By limiting the special power of appointment so that the trust assets can be left to any of your descendants, it guarantees that your assets will stay within your family line.

Separate Generation-Skipping Trust For Each Child

A good way to give each child maximum flexibility and control over assets, and all of the advantages and protections of a generation-skipping trust, is the trust would divide your assets into separate generation-skipping trusts so that there is one trust for each child in the trust instrument upon your death, or if you are married, upon the death of both you and your spouse.

Each child can then become trustee of their own generation-skipping trust and have total control over the investment of the assets and decisions to distribute assets to themself or their descendants. The trust would further provide that upon the death of your child, your child’s generation-skipping trust would further divide into separate generation-skipping trusts for each of your child’s children.

Each grandchild would then have all of the advantages and protections of a generation-skipping trust. Hawai‘i law allows for a trust to continue forever, as long as there are assets remaining in the trust, and as long as there is at least one Hawai‘i resident individual, bank or trust company serving as trustee.

It is our opinion that if the trust is properly drafted, particularly with the features of a special power of appointment and separate trusts for each beneficiary, that it is better for the child to inherit assets in the form of a generation-skipping trust than outright.

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Ethan R. Okura received his doctor of jurisprudence degree from Columbia University in 2002. He specializes in estate-planning to protect assets from nursing home costs, probate, estate taxes, and creditors.

This column is for general information only and is not tax, financial, or legal advice. The facts of your case may change the advice given. Do not rely on the information in this column without consulting an estate-planning specialist.


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