Trust funds set up for grandchildren are called generation-skipping trusts or dynasty trusts, reports CNN Money. They are designed to reduce estate and other taxes and set up so that the trust-maker's children receive income from the trust, but the principal is used for the grandchildren's benefit.
Assets passed from parents to children to grandchildren are normally subject to estate tax at each transfer, and if grandparents attempt to bypass children and transfer funds directly to grandchildren, the assets above the exemption amount are subject to generation-skipping transfer tax, according to NOLO. With generation-skipping trusts, the funds are subject to tax only once, when the assets are put into the trust by the grandparents. Because the funds remain in the trust, they incur no further taxes, although the money is used for the benefit of the grandchildren, subject to the terms of the trust.
Because generation-skipping trusts are irrevocable to protect them from challengers and creditors, trust makers must set them up with great care, cautions NOLO. Once they are set up, the trust maker and beneficiaries cannot change the terms. Typically, a trustee such as a trust company or bank manages the assets and uses them to meet the needs of the beneficiaries as delineated in the terms of the trust. The trust maker has the option for the trustees to maintain tight control or for the beneficiaries to have more flexibility with assets at a certain point.