This handout is designed to illustrate the use of an Irrevocable “Crummey” Trust (“Crummey Trust”) in an estate planning context and answer some questions you may have with regard to its use.
1.0 WHAT IS A CRUMMEY TRUST?
A Crummey Trust is a form of irrevocable trust. The trust is structured to receive gifts of cash or property without gift tax and to pass the assets to your heirs free of estate tax at some later date.
2.0 WHY DO I NEED A CRUMMEY TRUST?
Each person has the right to make annual gifts to any beneficiary of $15,000 per year (indexed for inflation) without gift tax under one’s annual exclusion. However, a gift to an irrevocable trust alone will not qualify under one’s annual exclusion because the gift tax rules require the beneficiary to have a present right to the gift — rather than simply a future interest in the trust. Therefore, to the extent you want to gift cash or property to your heirs in trust, a Crummey Trust is one method to qualify such gifts in trust under your annual exclusion and thus to avoid gift tax on the transfer.
3.0 HOW DOES A CRUMMEY TRUST WORK?
A technique was developed in the 1960’s to qualify gifts to a trust under the annual exclusion. This technique involves granting each beneficiary of the Trust the limited right to withdraw their portion of the gift for thirty days after each contribution. If the beneficiary fails to affirmatively exercise his or her right of withdrawal after being notified, the right lapses. While this technique is more complicated than gifting outright, no cash need pass directly to your beneficiaries and you can claim annual exclusion gifts for all beneficiaries. For example, if you have five children and three grandchildren, you could gift up to $120,000 of cash or property to the Trust under your annual exclusion (and up to $240,000 if you are married). While you must issue withdrawal notices to qualify the gifts to the Trust for your annual exclusion, this is a relatively simple procedure.
4.0 WHAT ADVANTAGES DOES A GIFT IN TRUST PROVIDE TO AN OUTRIGHT GIFT?
An irrevocable trust provides the following advantages over direct ownership by your heirs:
(a) Continued Control over Property. Rather than passing the gifted property to your heirs outright, an irrevocable trust allows you to control the timing and amount of distributions by designating the ages at which distributions should be made from the trust to your heirs. This not only prevents the assets from passing to your children at too young an age, but can be used to prevent distributions from being made if a child is then in bankruptcy, in the middle of a divorce, or is physically or mentally incapable of handling the proceeds. In addition, because you select the Trustee who will manage the assets (and can choose yourself if desired), you can effectively retain continued control over the property during your life.
(b) Creditor Protection. By holding the property in Trust, the property will not be subject to your creditors or to your heirs’ creditors. Keeping the property in trust can also prevent your heirs from commingling the separate property proceeds with their community property — thereby preventing the spouses of your heirs from acquiring an interest in the property.
(c) Allows Generation-Skipping.With some advanced planning inside the Trust, you can prevent estate tax from being imposed on the property at your children’s death as well as at your own death. This allows you to benefit both your children and successive generations and can result in millions of dollars of tax savings.
5.0 WHAT ARE THE POSSIBLE DISADVANTAGES TO A CRUMMEY TRUST?
5.1 Issuance of Withdrawal Notices. As discussed above, in order to qualify gifts to the Crummey Trust under your annual exclusion, the Trustee is required to issue notices to each beneficiary of his or her right of withdrawal on an annual basis. However, you are not required to give each beneficiary the same right of withdrawal and can choose to deny a specific beneficiary a right of withdrawal in any year (thereby reducing the amount that can be gifted to the Crummey Trust without tax that year). Therefore, to the extent a beneficiary chooses to exercise his or her right to withdraw the contributed funds, you have the ability to deny him or her future access to the gifted assets.
5.2 Terms of Trust Irrevocable. Because the Crummey Trust must be irrevocable to avoid inclusion in your estate, you may not change the beneficiaries or alter their distribution rights. However, if you later decide not to pass your wealth to the designated beneficiaries, you may always discontinue gifting to the Trust.
Clay R. Stevens © 2013