The generation-skipping transfer tax (GSTT) often impedes people who wish to leave assets to their grandchildren. The GSTT is the IRS’s way of ensuring such gifts—as well as the grandparent’s estate—do not escape taxation.
However, there is a way for you to make such gifts without incurring the GSTT and that’s through the creation of a Health and Education Exclusion Trust (HEET). As the name implies, these trusts can only pay for the medical and/or educational needs of your grandchildren and their descendants.
Why HEETs are Hot
While grandchildren or their descendants can benefit from a HEET, there’s a catch: at least one beneficiary must be a charitable organization. Having a charity involved prevents a HEET from acting as a garden variety generation-skipping trust. Charitable beneficiaries receive funds as “qualified transfers” as per IRS rules. The amount of income received by the charity annually depends on the individual HEET. However, it’s wise to consider an amount between 6 and 10 percent in order to pass IRS scrutiny.
A HEET can be used to pay the educational expenses of a your grandchildren. Unlike a 529 plan, it can be used to fund education at any level, from kindergarten to graduate school. While HEETs can’t benefit your children directly, they do so indirectly by removing a parent’s financial obligations to pay for educational expenses. Additionally, medical insurance premium payments for descendants also qualify under HEET. If the HEET is created during your lifetime, it is an irrevocable trust and not part of the estate—thus minimizing a your estate tax liability. Since people permanently lose access to HEET funds in an irrevocable trust, some may decide to fund a HEET via a will or revocable trust. In this instance, the HEET will go into effect posthumously. It’s important to note, that HEETs created in this manner are subject to applicable estate taxes.
Additionally, a HEET doesn’t just benefit the client, it can also benefit the attorney that prepares the trust. If a trust is not irrevocable or allows the grantor to make modifications to the trust over time—such as add more beneficiaries or set aside additional property for funding the trust—HEETs are a good opportunity for recurring business. While HEETs can be quite time consuming to create, there are tools that provide document automation and built-in adaptability; allowing attorneys to draft HEETs and other types of estate planning documents efficiently and with the flexibility that you require.