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Crummey Trust: Definition – Overview – Example

What Is a Crummey Trust?

Crummey TrustA Crummey trust is an estate planning tool that takes advantage of the gift tax exclusion while limiting the recipient’s access to the funds. It allows you to give money or assets to another person while keeping the flexibility to place limits on when the recipient can access the money.

A Crummey trust is named after Clifford Crummey, the originator of this form of trust.  It is intended to provide financial transfers to beneficiaries while reducing gift tax. This sort of trust is commonly used by parents who desire to make financial contributions to minor or adult children.  However, it can be established by anybody on behalf of a beneficiary. For example, Crummey trusts can be used as an alternative to custodial accounts.  This spares the requirement that an adult manages assets until the beneficiary reaches the age of majority. A custodial account automatically provides children ownership of assets after they reach legal age.  However, a Crummey trust can provide more flexibility and control over when beneficiaries can access assets.

Crummey Trust – A Closer Look

A Crummey trust is commonly utilized by parents to make lifelong gifts to their children.  At the same time, it shields their money from gift taxes.  Of course, the gift’s value must be equal to or less than the allowed yearly exclusion threshold. This threshold is $15,000 per recipient for the tax year 2021, increasing to $16,000 in 2022.  A Crummey trust allows a family to continue making the yearly $15,000 payment.  All the while, the funds are in a safe place and shielded from the Internal Revenue Service’s gift taxes.

The yearly gift tax exception does not normally apply to gifts given to trusts. For the exception to apply, the IRS requires the gift receiver to have a present interest in the gift. As long as the beneficiary is not a juvenile under the age of 18, they must have instant access to the gift. Many different types of trusts provide beneficiaries with a future interest in the trust’s assets.  To address the present interest issue, a Crummey trust must permit a qualified receiver a withdrawal window.  For example, the gift can be withdrawn within a specified time frame, such as 30 or 60 days following the transfer. Beyond that point, the gift monies kept in the trust are subject to the grantor’s specified withdrawal requirements.

History of the Crummey Trust

Clifford Crummey was the first successful taxpayer to apply this strategy when he created his trust in 1962. His efforts and success inspired the name of the Crummey trust. Initially, the Internal Revenue Service (IRS) sought to deny him and his family the yearly gift tax exception. The IRS claimed that the trust did not fulfill the gift tax exclusion’s immediate interest requirement. The legal proceedings carried on for several years. Finally, in 1968, the courts sided with the Crummeys and decided in their favor. As a consequence, the Crummey trust remains a viable alternative for families.  Particularly those who want to make lifetime contributions to their children while avoiding gift taxes.

Advantage of a Crummey Trust for Estate Planning

The primary benefit of adding a Crummey trust in your estate plan is the advantageous tax treatment of cash donations.  A Crummey trust permits the creator to convey assets to the trust’s beneficiaries free of both gift and estate taxes. Of course, this assumes your recipient does not remove assets from the trust during the restricted withdrawal period.  From that point on, any money transferred to the trust on their behalf qualifies for the yearly gift tax exclusion. If the recipient does not take assets from the trust during the withdrawal period, the gifts can be invested and secured in the same way that gifts from other types of trusts are.

The Disadvantage of the Crummey Trust

One possible disadvantage of the Crummey trust is the present interest requirement.  Giving recipients, especially minors, immediate access to large donations may damage the fund’s capacity to accumulate returns over time. However, many families get around this by imposing conditions on immediate withdrawals.  For example, restricting the amount or frequency or prohibiting future gifts to recipients who withdraw cash immediately. A parent, for example, might specify that a child cannot access trust funds until the age of 25. Even if the beneficiary wishes to use the trust’s money, they will only be able to access the most recent contribution. All prior donation amounts are still safe and protected in the trust account.

A Crummey Trust and the Present Interest Requirement

Typically, when setting up this type of trust, the beneficiary has a set window of time in which they can withdraw assets. For example, they may be able to do so within the first 30 days after the trust is created and funded. This withdrawal power satisfies the present interest requirement for the financial gifts included in the trust. This feature is what allows you to minimize gift taxes or avoid them entirely when giving money to minor children or any other beneficiary.

The beneficiary might potentially remove assets from the trust during this time period.  However, it is doubtful that a minor child would do so. Assuming that no assets are removed during this time, any financial donations you’ve made will remain in the trust.  They will then be distributed to the recipient or beneficiaries in accordance with the conditions and schedule you’ve established. It is the trustee’s responsibility to guarantee that the provisions of the trust you’ve established are followed.

Example

The yearly gift tax exception allows you to offer yearly gifts worth up to a certain amount without paying gift tax. The cap for 2021 remains at $15,000 per recipient. This sum is inflation-indexed and goes to $16,000 in 2022.  So, imagine you have three adult children and three grandkids, you may give each one $15,000 this year, for a total of $90,000, and pay no gift tax. (Alternatively, for cash gifts provided jointly by a married couple, the exclusion is doubled to $30,000 per year doubling your potential total to $180,000.)

Available Options

  • Give the cash outright –  If you give the cash or other assets outright, you run the risk that the money or property could be squandered.  This is especially possible if the recipient is young or irresponsible, as are grandkids.
  • Traditional trust – You can transfer assets to a traditional trust and name each as a beneficiary. However, this arrangement does not qualify as a gift with present interest.  Present interest is defined as an unrestricted right to the immediate use, possession, or enjoyment of the property or the income from it. With a traditional trust, the designated trustee manages the assets until the child reaches a specified age. However, to qualify for the annual exclusion, a gift must be a transfer with present interest. When a gift is placed in a trust and accumulates income without being distributed to the beneficiary, it doesn’t qualify as a gift of a present interest. Instead, it is treated as a gift of a future interest that is subject to the gift tax.
  • Crummey Trust – A properly established Crummey Trust satisfies the rules for gifts of a present interest. This is accomplished without the trustee being required to immediately deliver the assets to the beneficiary. Periodic donations of assets to the trust are typically coupled with a temporary power granting the recipient the ability to withdraw the contribution for a brief time window. Of course, the donor anticipates that the temporary right to withdraw will not be used. Nevertheless, this temporary withdrawal right, is what qualifies the gift as a gift of a present interest. As a result, it is eligible for the yearly gift tax exception. The presence of the legal right to withdraw, rather than its use, decides the tax consequence.

Up Next: What Is Agency Theory?

Agency TheoryAgency Theory describes how to effectively manage partnerships in which a principal specifies which job to undertake while an agent actually does it. In general, agency theory is used to understand and address problems in the connection between corporate owners and their agents. That connection is most typically between shareholders, as principals, and firm executives, as agents.

According to agency theory, companies function as agents for their shareholders. That is, shareholders, engage in corporate ownership and thereby entrust their resources to the administration of the corporation’s directors and officers. In bigger organizations, there is frequently a substantial difference between executives’ and shareholders’ immediate and long-term interests. This is largely due to the short-term need for profits and earnings as well as the asymmetrical knowledge that officers and directors have in comparison to shareholders.

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