There are very tax efficient ways to pass wealth from a parent to a child when there are potential estate tax considerations.
Using Crummey Trust for Tax Free Gifts to Children
Oftentimes inter-generational wealth is passed by amounts not exceeding the gift tax exclusion limit. Many parents and grandparents make their annual gifts to a custodial account under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). These laws will be different in each state. It is important to check if a state follows UGMA or UTMA, but this information on the accounts will generally be correct.
What is a UGMA and UTMA account?
An UGMA or UTMA account works well and is easy to create and maintain. These are creations of state laws and most states have this option available for their residents. However, using UGMA or UTMA accounts have one major defect: when the child (or grandchild) reaches age 18 or 21, depending on the state in which the beneficiary resides, the beneficiary can do whatever he or she wants with the money in his or her custodial account. For example. the child could take the money and go on a big vacation instead of spending it on their college education.
What is a Crummey Trust?
Most parents do not want their children to have unfettered access to money when they turn 18 or 21. Fortunately, there is a special kind of trust that avoids this problem. It’s called a “Crummey” trust, after a court case that paved the way for the use of this kind of trust. This is an estate planning technique that can be employed to take advantage of the gift tax exclusion when transferring money and/or assets to another person, while placing limitations on when the recipient can access the money.
Why use a Crummey Trust?
With a Crummey trust, the property can remain in trust for as long as you wish without forfeiting the gift tax annual exclusion. Thus, you can transfer property to remain in a Crummey trust for the beneficiary’s entire lifetime or until an appropriate age (e.g., age 30) or event (e.g., graduation from college). You decide how the money is to be used and how much the beneficiary can receive.
Annual Contributions Crummey Trust
Annual contributions you make to the Crummey trust won’t qualify for the gift tax annual exclusion unless you notify the beneficiary that you’ve made the contributions, and give him or her a limited period of time (usually 30 days) in which he or she can withdraw the contributions from the trust. It’s usually understood that the beneficiary won’t exercise his or her right to withdraw the contributions, but will let them remain in the trust.
Special Considerations on using a Crummey Trust
However, that expectation should always remain unwritten because, if there’s any evidence of it, IRS will use that evidence to say that the beneficiary didn’t really have a power of withdrawal. If the beneficiary violates the unwritten understanding by withdrawing property from the trust, there’s nothing you can do about it, except to show your displeasure by not making any further contributions to that beneficiary’s trust.