Many grandparents are looking for ways to gift education and medical expenses for grandchildren and more remote descendants. The Tax Code provides that direct gifts for tuition and medical expenses are excluded from the gift tax or Generation Skipping Transfer Tax (“GSTT”). IRC 2503(e). These expenses must be made directly to the education or health care provider and can only be made during the grandparent’s lifetime. A Health and Education Exclusion Trust (“HEET”) is one way to fund the education and medical expenses after the grandparent’s passing for future generations. A properly drafted HEET can also avoid GSTT

A short explanation of the GSTT. For estates over the applicable exclusion amount, $13.99 million in 2025, generation skipping transfers are taxed at 40%. There are three ways GSTT is imposed. A transfer made directly to a skip person, grandchildren or great-grandchildren, either during lifetime or death is a direct skip. A trust which has both children and grandchildren as beneficiaries, will pay GSTT when it makes distributions to a grandchild, known as a taxable distribution. Finally, for a trust which has both children and grandchildren as beneficiaries, when the last child dies, GSTT is imposed on the remaining value of the trust, known as a taxable termination.

The HEET seeks to avoid taxable distributions and taxable terminations. The Tax Code provides that for assets held in trust, a distribution to a provider for education or medical expenses on behalf of a beneficiary is not considered a taxable distribution for GSTT purposes because if the payment had been made while the grantor was alive it would not a be taxable gift. However, without special provisions, upon the death of the last non-skip person, distributions from the trust would become taxable terminations subject to GSTT. The HEET avoids this taxable termination by adding a charitable beneficiary to the trust. A charitable organization is classified as a non-skip person for GSTT purposes. As long as one of the beneficiaries is a charitable organization, the trust will never experience a taxable termination.

A HEET can be created while living, inter vivos, or at the grantor’s death. An inter vivos HEET is typically funded with the grantor’s annual and lifetime gift exemptions currently $19,000 per year or $13.99 million lifetime. It can also be an irrevocable life insurance trust drafted as a HEET. Assets used to fund a testamentary HEET would be subject to the estate tax, but not GSTT. Distributions made from the HEET on behalf of beneficiaries must be qualified transfers. For educational expenses, this means payments for tuition. The cost of room and board and books are not covered. For medical expenses, distributions may be made for hospital care, nursing care, laboratory, surgical, dental, diagnostic services, drugs, and ambulance among others. Distributions may also be made for medical and dental insurance premiums. However, distributions may not be made for elective surgeries. It is recommended that an independent trustee be appointed and that distributions from the trust be fully discretionary so that the trustee can confirm that the distributions are appropriate.

As noted, the HEET must also contain a charitable interest which must be substantial. There is no official guidance on what constitutes a substantial interest; however, many practitioners recommend that 10% be distributed annually to the charity. The charitable interest can also be a family foundation. There is no charitable deduction when an inter vivos HEET is established nor is there a charitable deduction when it is created at death. However, by making the HEET a grantor trust during the grantor’s lifetime, the grantor will pay the trust’s income tax and will also receive the charitable deduction subject to the normal limitations. At the grantor’s death when the trust becomes a separate taxpayer, the trust will take the charitable deduction.

A HEET generally works best for very wealthy individuals who have fully used their GSTT exemption. Like any other dynasty trust, it is established for the benefit of multiple beneficiaries over multiple generations. Grandparents wishing to provide for grandchildren and more remote descendants who also have charitable inclinations should consider if a HEET is right for their family.