What is Generation-Skipping, and How Might it Affect Sandwich Generation Parents?

When grandparents leave their estate directly to their grandchildren, the emotional pain and financial strain can be devastating for Sandwich Generation parents. This demographic both cares for their aging parents while also supporting their own children. Sandwich Generation adults often rely on their eventual inheritance to pay off debt incurred by their parents’ medical care, recoup drained retirement savings, and continue caring for their growing children. Let’s take a closer look at why grandparents might generation skip, ways in which this transfer impacts Sandwich Generation adults, and how they can deal with the fallout gracefully.

What Exactly is Generation Skipping?

We use the term “generation skipping” in the context of inheritance and estate planning. Generation-skipping is a strategy whereby assets are transferred directly from grandparents to their grandchildren. That inheritance bypasses the intermediate generation (the children of the grandparents).

Grandparents might “generation skip” to manage the distribution of wealth within their family and ensure that their assets directly benefit the youngest generation. Generation-skipping can provide grandchildren with resources for education, housing, or other needs without relying on their parents to faithfully execute the grandparents’ wishes.

It’s also a tax strategy. Generation skipping can reduce the federal estate tax burden that would arise if the assets were transferred through each generation in direct succession. However, the IRS does lobby a generation skipping tax, so it’s not quite cut and dry.

Tax Implications of Generation Skipping

In the United States, generation skipping is governed by specific laws and regulations like the Generation-Skipping Transfer Tax (GSTT). The GSTT is an additional tax imposed on transfers that skip a generation. It was designed to prevent wealthy individuals from avoiding estate taxes by directly transferring significant wealth to grandchildren or younger generations.

This tax is levied on top of other applicable estate or gift taxes. Let’s talk about how the GST tax—as well as estate and gift taxes—can impact a family’s inheritance.

What is an Estate Tax?

An estate tax is a levy on the total value of a deceased person’s estate before distribution to their heirs. This tax is imposed on the right to transfer property at death and is calculated based on the fair market value of the assets within the estate. These assets might include real estate, cash, securities, and personal property. In the United States, the federal estate tax has a specific exemption threshold, which means that only estates exceeding this threshold are taxed.

As of 2023, the federal estate taxes exemption amount is $12.92 million per individual. In addition to the federal estate tax, many states also impose their own estate taxes. These state estate taxes can impact the total tax liability of an estate, which is why individuals should consider both federal and state estate tax laws in their estate planning.

What is a Gift Tax?

A gift tax is a federal tax imposed on the transfer of money or property from one individual to another while receiving nothing in return. This tax is designed to prevent individuals from avoiding estate taxes by giving away their assets before they die. The donor is usually responsible for paying the gift tax, but the recipient might need to in some cases.

Not all gifts are subject to gift tax. The IRS exempts certain types of transfers from gift tax like gifts to spouses, charitable donations, and payments made directly for medical expenses or tuition on behalf of someone else. These specific exemptions encourage individuals to support family members and charitable organizations without worrying about incurring that gift tax.

The IRS allows for an annual exclusion amount, which is the amount a person can give to any number of recipients each year without incurring gift tax. As of 2023, the annual exclusion amount is $17,000 per recipient. This means that an individual can give up to $17,000 to as many people as they wish each year without having to pay gift tax or even report the gifts to the IRS.

There is also a lifetime exemption amount that applies to gifts exceeding the annual exclusion. This lifetime exemption is tied to the federal estate tax exemption. Gifts that exceed the annual exclusion amount must be reported on a gift tax return (IRS Form 709), but no gift tax is due until the total lifetime gifts exceed the lifetime exemption amount. Once this exemption is exceeded, the donor must pay gift tax on the excess amount at the current gift tax rates, which can be as high as 40%.

How Gift, Estate, and GST Taxes Impact a Family’s Estate Planning

These taxes directly influence how wealth is transferred across generations. The GSTT is intended to discourage generation skipping transfers, which a grandparent might use to avoid estate taxes. Estate and gift taxes could dramatically reduce someone’s inheritance, but there are ways for grandparents to avoid the gift or estate tax as they plan. Let’s review.

The GSTT exemption allows individuals to transfer up to $12.92 million (as of 2023) to skip-generation beneficiaries like grandchildren without incurring the tax. Grandparents can also use the annual gift tax exclusion, which lets them give up to $17,000 per year per grandchild tax-free. Many use GSTT-exempt trusts to avoid this tax. To claim the exemption, grandparents must file IRS Form 709 as part of their federal estate tax return, the United States Gift (and Generation-Skipping Transfer) Tax Return, for gifts exceeding the annual exclusion amount.

Who are the Sandwich Generation and Why is Generation Skipping Such a Big Deal for Them?

The Sandwich Generation refers to a group of middle-aged adults who are simultaneously responsible for caring for their aging parents and their own children. Most Sandwich Generation adults are in their late 30s to early 50s. Many find themselves ‘sandwiched’ between two demanding caregiving roles. That’s about a quarter of all American adults.

These adults often provide financial support, emotional support, and physical care to their parents while also managing the upbringing and educational needs of their children. The dual responsibility can produce both emotional stress and financial strain as parents balance the needs of both generations.

This situation has become more common as life expectancies rise and people have children later in life. According to a Pew Research Center study, about 12% of parents with children under 18 are also providing care for their aging parents. The Bureau of Labor Statistics recently reported that “Twenty-one percent of eldercare providers, or 7.8 million, were also parents of children under age 18 living at home.” This demographic shift means that more families are struggling against the challenges of multigenerational caregiving.

The financial strain can be intense, too, with many sandwich generation adults contributing a substantial portion of their income to support both their children and their parents, often without sufficient savings for their own retirement. Many of these adults struggle to financially care for the two generations that sandwich them. In fact, that same BLS report found that “Seventy-one percent of eldercare providers who were parents of children under age 18 living at home were employed full time.”

How Generation-Skipping Affects Sandwich Generation Parents

Generation skipping can be particularly detrimental to Sandwich Generation parents because it exacerbates already heavy emotional and financial pressures. From loss of inheritance to legal considerations, let’s take a closer look at how generation skipping could impact adults who care for both elderly parents and children.

Loss of Expected Inheritance

The loss of expected inheritance through generation-skipping can disrupt anyone’s financial planning. Sandwich Generation adults often anticipate receiving some financial support from their elderly parents’ estates. After years of caring for those elderly parents, Sandwich Generation adults might use their inheritance to cover the costs associated with that care, offset their own expenses, support their children’s education, or bolster their depleted retirement savings.

Without this inheritance, they might face a financial shortfall that forces them to adjust their financial strategies. This could add to their debt or delay important financial goals like buying a home or retiring comfortably.

Increased Financial Burden

With the assets bypassing them and going directly to their children, sandwich generation parents may find themselves with more financial responsibilities than before. They are still tasked with supporting their aging parents and their children without the additional resources they had hoped to receive. Their out-of-pocket expenses could skyrocket, as they may need to fund their parents’ medical and living expenses—plus their children’s education and living costs—entirely on their own.

Need for More Focused Savings and Retirement Planning

Sandwich generation parents must compensate for their lost inheritance by saving more aggressively and investing wisely to ensure they can meet their financial obligations and secure their own retirement. They might need to cut back on current expenses, seek higher income opportunities, or make more prudent investment choices to build a robust financial cushion that can sustain them in their later years.

Feelings of Being Overlooked

Not all of the fallout from generation skipping is financial. There’s an emotional element, too. When grandparents make the decision to skip a generation in their estate planning, Sandwich Generation parents often feel overlooked or undervalued. This can strain family relationships by breeding resentment and disappointment. Parents might feel that their contributions and sacrifices are not being recognized or appreciated, which can create tension and discord within the family dynamic.

Added Stress

The added financial pressures that come from the loss of an expected inheritance can be incredibly stressful. Managing the dual responsibilities of caring for aging parents and raising children is already so demanding. The absence of additional financial support exacerbates these challenges. The constant worry about meeting financial obligations and ensuring the well-being of both generations can affect their mental health and quality of life.

Legal Complexities

When grandparents decide to skip a generation and leave their estate directly to their grandchildren, they introduce unexpected legal complexities. The parents who were skipped might want to contest the will if they believe they were unfairly excluded. Contesting a will can be a lengthy and costly legal process.

The grandchildren might also find themselves mired in legal complexities. They might be subject to the Generation-Skipping Transfer Tax (GSTT), which is a tax on assets transferred directly to them. As noted above, this tax is designed to prevent families from avoiding estate taxes across generations, and it can be quite high.

Plus, managing a large inheritance can be a tall order for young adults. Their parents may need to provide guidance while they struggle against their own emotions and financial burdens. To do so, they might help their children set up trusts, handle investments, and ensure they understand the legal responsibilities that come with their new assets.

Final Thoughts: How to Deal as a Skipped Sandwich Generation Parent

Few of us can just shrug off generation skipping—especially when we have cared for both our elderly parents and our growing children. It can take an enormous emotional and financial toll. If possible, try to foster open and honest communication within the family to address feelings of being overlooked and to find mutual understanding with your parents. Consider seeking support from counseling or support groups to help manage your stress.

If you come to resent your children (the new beneficiaries of your parents’ estate), find a therapist you can trust. Your children are not at fault, but it can be difficult to separate your feelings about the financial situation from your relationship with them. A therapist will help you process these emotions in a healthy way.

Of course, you must also reassess your financial plans as soon as possible. Focus on building a robust savings strategy and think about exploring alternative income sources or investments to compensate for your lost inheritance. Consulting with financial advisors and estate planning professionals to navigate these complexities and support your own financial stability.

We understand how devastating this loss can be—both for your retirement and for your family dynamics. But with the right support and strategic planning, you can rise above.