What is a Crummey Trust?
Providing financially for children and grandchildren is one of the most satisfying ways to use the assets you've spent a lifetime accumulating. Of course, you have made an estate plan to dispose of your assets after you're gone, but you want to be able to have the joy of giving while you're still alive. Not only does giving during your lifetime allow you to experience the gratitude of your beneficiaries, but making lifetime gifts can be an excellent way to reduce your taxable estate.
As of 2017, you can make a gift of up to $14,000 as an individual (or $28,000 for a married couple) to a child or grandchild each year without incurring gift tax liability on that amount. This gift can be used for their education, travel, even a down-payment on a house when the time comes. But how you give the gift has a significant impact on the benefit you and the beneficiary will get out of it.
Limitations of Custodial Accounts and Regular Trusts
You don't want to give a large financial gift directly to a minor child, as legally, they do not have the capacity to own property and someone would need to be designated to manage their property for them—a legal hassle. You could always choose to put funds in a what's known as a custodial account for the child. The problem with that is that the custodial nature of the account ends when the child reaches the age of majority, which is 18 in Ohio. You can well imagine the dangers of someone who is a legal adult, but in reality barely out of childhood, suddenly having unfettered access to a large amount of money.
You could create a trust for the child's benefit, and that would solve the problem of all of the funds falling into the child's hands when they turn 18. Unfortunately, using a regular trust to make these gifts has significant tax consequences. In order for you to be able to make your $14,000 gift and not have it be subject to gift tax, the recipient must have a "present interest" in the gift money. But when the money goes into a trust, that is effectively a promise to give the child money at some future date. The promise of a future gift doesn't count as a present interest in the funds, and as a result, most such gifts made to trusts cannot be excluded from the gift tax.
However, there is an option that allows you to both keep the money safe until the child is mature enough to handle it, and also to take the gift tax exclusion: the Crummey trust.
How a Crummey Trust Works
Crummey trusts are named after the legal case that first approved this specific type of trust. Crummey trusts are designed to achieve the dual goals of giving the donor a gift tax exclusion and protecting the gift from impulsive spending by the recipient.
Here is how it works: in order to create a present interest in the gifts that are made, the trust provides the beneficiary a limited window in which to withdraw funds from the trust if they choose—typically 30 days. After the window closes, the beneficiary can no longer withdraw the gift funds, and they become part of the trust. Once this happens, you have the ability to control the amount and timing of any distributions to your beneficiary.
It is essential to give the beneficiary proper notice of the gift, their right to withdraw it, and the time limitation. If proper notice is not given, the gift tax exclusion cannot be applied and the gift will be subject to tax.
Doesn't this mean that the beneficiary could choose to withdraw the funds, subverting your goal of keeping the money safe from impulsive spending? It absolutely does. The right to withdraw the funds must be real, not illusory, in order to qualify for the gift tax exclusion. That said, there is nothing to keep you from talking to to your beneficiary and saying that you hope they will not actually make a withdrawal, and that doing so may mean you will not make future gifts. In this scenario, most beneficiaries decide to delay instant gratification in favor of future benefit.
If a Crummey trust sounds like it might meet your needs, speak to your estate tax attorney about what you need to do to establish one.
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