A “Crummey” Idea (Part 2 of 2 – Continued from “The Estate Freeze”)

In my last blog, entitled “The Estate Freeze,” I described an Estate Planning technique known as an “Estate Freeze” whereby you make gifts during your lifetime, take the Estate and Gift Tax consequences now, and allow those assets to appreciate in your beneficiaries’ estates rather than in your own estate.  This technique often involves consideration of the federal Gift Tax Exemption and the annual exclusion, allowing you to gift up to $13,000 per person per year.  However, what if you want to take advantage of this technique but still want control over the gifts?  For example, you may have beneficiaries who are minors such as children or grandchildren.  The solution is an irrevocable trust known as a “Crummey Trust.”

In order to maintain control, the idea is to make gifts to an irrevocable trust rather than to the beneficiary directly.  The fact that the trust is irrevocable and has certain features means that the gifts are no longer part of your estate.  The trust outlines circumstances in which the gifts may be used on behalf of the beneficiary and also names a Trustee – a trusted third party – who will follow the trust’s guidelines.  

When attorneys first came up with this concept, they encountered a problem: in order for the annual $13,000 exclusion to apply, such gifts needed to be a “present interest,” meaning that the beneficiary has to be able to use the gift right away.  This contradicts the whole point of setting up the trust in the first place – to prevent the beneficiary from having unfettered access to the gift.

To combat this problem, Estate Planning attorneys developed the concept known as a “Crummey Trust,” named after a famous Court case that upheld this structure.  The trust includes language that states each time a gift is made to it, the beneficiaries have a certain window of time (usually between 30 and 60 days) to demand that the gift be given directly to them (“demand right.”)  After that period of time, the beneficiary no longer has any right to demand the gift and instead it is subject to the restrictions of the trust.  The existence of the demand right satisfies the “present interest” requirement and thus the annual $13,000 exclusion applies to the gift.  However, the beneficiary must know that he or she has this demand right.  As a result, each time a gift is made to the trust, the Trustee must send the beneficiary a letter informing him/her of the demand right.  This is known as a “Crummey Letter.”  

While it is true that during the window of time the demand right is open, the beneficiary could simply demand the entire gift, the beneficiary will learn that if he or she ever exercises that right, you will no longer make any gifts into the trust at all.  The beneficiary will see the “big picture” and allow the demand right to lapse so that you will not be discouraged from making future gifts to the trust.

This can be a powerful gifting tool.  Crummey Trusts are often used with life insurance (also known as an “Irrevocable Life Insurance Trust” or an “ILIT”) but can be applied to a broad range of situations.  One key exception is beneficiaries with Special Needs: because of typical concerns with maintaining public benefits, Crummey provisions cannot be inserted in Special Needs Trusts.

It is paramount that Crummey Trusts are “maintained” in that the Trustee must send Crummey Letters to the beneficiaries each year a gift is made.  For good measure, the beneficiaries should acknowledge receipt of the Crummey Letters.  Failure to issue Crummey Letters could collapse the entire plan.