Sometimes, the old ways are best.
Crummey Trusts – named after D. Clifford Crummey who won a fight with the Internal Revenue Service in the 1960s – are designed to protect life insurance from federal estate taxes.
Many advisors are saying that this strategy makes a lot of sense right now, even in this time of high exemptions for estate and gift taxes, according to the Wall Street Journal (http://tinyurl.com/7jynlmn).
Despite the fact that Congress raised the lifetime threshold for tax-free giving from $1 million last year, the ceiling could fall back down again in 2013, or the government could decide to “claw back” gift and estate tax savings from this year.
Crummey Trusts 101
Crummey Trusts are best used for making gifts to minors, such as when a parent is giving money to a child who isn’t ready to handle a large sum. Grandparents often use them to pass money to grown children or fund a college savings 529 plan. Crummey Trusts are also used to buy life insurance policies and fund the premiums with annual gifts.
Each year, you can give unlimited separate gifts of up to $13,000 to as many people as you want. This gets the money out of your estate and avoids triggering the gift tax. Since the Trust owns the policy, the death benefit goes to the Trust, shielding it from estate taxes.
The benefits of a Crummey Trust can be written into other kinds of planning strategies, such as a Dynasty Trust and a Generation-Skipping Trust, simply by adding withdrawal powers.
Down to the Letter
There is one crucial aspect of the Crummey Trust that must be followed for this strategy to work.
The trustee must send out Crummey Letters each year informing beneficiaries that they can withdraw the gifted amount during a window of time, say 30 days. Most beneficiaries leave the money in the Trust. However, the IRS considers it a tax-free gift only if an heir has the right to take it in the short term; the Crummey Letter establishes this right.
It’s easy to overlook the importance of sending out these letters on time. While the trustee is often a family member or friend of the deceased, we advise clients to hire a professional, such as an accountant or our firm, to send out the letters each year to ensure every requirement has been met.