It is important to take steps to preserve your assets as you pass them along because there is a powerful force that will be standing at the ready waiting to pounce when it is time for the distribution to take place. We had a brief respite from it in 2010 because it was temporarily repealed, but the force will be back in 2011 and it is called the federal estate tax. The maximum estate tax rate is going to be 55% unless there is some change enacted, and paying such a draconian levy is clearly something that most people would like to avoid if it is at all possible.
One strategy that can be used to sidestep the harsh bite of the estate tax is the creation of a generation-skipping trust. Consider a scenario where your parents left their estate to you and it was reduced by half due to the estate tax. You have built some wealth on your own, so at the end of your life you still have everything that you inherited from your parents. When you leave those assets to your children, they are going to be cut in half once again by the IRS. And this will go on and on down the line.
With a generation-skipping trust you avoid the above situation. You create the trust with your grandchildren as the beneficiaries, and it is subject to a generation-skipping transfer tax, but there is an exemption of around $1.3 million. Your children can receive distributions from the trust and even control the disposition of the assets within the trust (to other parties) through a special power of appointment. In this manner your assets are transferred, your children can benefit from them, and no estate tax can be levied.
Your children can then set up a generation-skipping trust funded with their own accumulated assets, and the family wealth can be passed on from generation to generation without being steadily eroded by the estate tax.