The Crummey Trust (not be confused with a "crummy" or lousy, trust) is a well-established estate planning tool that allows you to gift up to $15,000 per person each year without incurring a gift tax. Or it can be $30,000 per year if gifted by a married couple. It is often used to pass wealth to children and minors. It is also commonly used in irrevocable life insurance trusts.
One of the advantages of a Crummey Trust is that it allows you to determine when a beneficiary can withdraw the money each year. This feature is especially useful when giving money to children who aren't mature enough to handle it. It's also an attractive alternative to a custodial account, which allows children to have access to the money when they reach 18 or 21.
Future Interest vs. Present Interest
So how does the Crummey Trust avoid the gift tax? It all comes down to "present interest" ownership versus "future interest" ownership. In a regular estate trust, gifts are considered "future interests" and are taxable.
But, with the Crummey Trust, money can be gifted into the trust while providing the beneficiary the temporary option to withdraw that precise amount, or less, usually within 30 days. The option to withdraw the funds means that it falls under the "present interest" rule, making it a tax-free gift under the Section 2503 (c) exception of the Tax Code. After 30 days, if the beneficiary waives the right to withdraw the money, then he or she can no longer withdraw it, and it remains as a part of the trust.
One of the most important elements of the Crummey Trust is the need to inform the beneficiary of his or her right to withdraw the gift. Otherwise, the IRS will tax it. Most estate advisors suggest a letter ― known as a Crummey Letter ― as the best way to inform the beneficiary. Even a child must be informed in writing that the gift is available for withdrawal.
A Crummey Trust is an irrevocable trust, which means that you need to carefully consider all the consequences of such an estate structure. Because once established, an irrevocable trust is permanent and all but impossible to change. There are a lot of good reasons to set up an irrevocable trust, including the fact that it can be defined ― in the most ideal circumstances ― by simplicity. This makes its execution less controversial and less complex. But, that said, an irrevocable trust removes your ownership rights over the assets.
Irrevocable Life Insurance Trusts
The Crummey Trust provisions are sometimes used in irrevocable life insurance trusts (ILITs). By invoking Crummey Trust powers, an ILIT can be funded under the annual gift tax exclusion. If set up correctly, then beneficiaries will receive the insurance proceeds free of estate and income taxes.
The Crummey Trust was named after Clifford Crummey, who was sued by the IRS in the 1960s for trying to take advantage of a similar tax loophole. The court ruled in favor of Crummey, and the Crummey Trust concept came into being.
If you have questions about the Crummey Trust structure, or any questions about estate planning, then please feel free to contact me at (858) 792-3444. I look forward to helping you preserve your financial legacy.