Crummey trusts are highly tax-advantaged. They also have a number of non-tax benefits. If you’ve read our overview of Crummey trusts — “Crummey Trusts: Everything You Need To Know” — you’re familiar with those tax and non-tax benefits. But Crummey trusts aren’t the only way for someone to use his or her gift-tax annual exclusion. There are three other common strategies:
- Making outright gifts to heirs.
- Opening a custodial account under the Uniform Transfers to Minors Act (UTMA) or a similar law. A custodial account is a special type of financial account that is set up and managed by an adult (the custodian) for the benefit of a minor (the beneficiary).
- Funding a 529 plan — a type of tax-advantaged account for educational expenses.
The purpose of this article is to flesh out these alternative strategies, and compare them to the Crummey trust approach.
Why Use Crummey Trusts to Make Annual Exclusion Gifts?
Here are the top five reasons people set up these trusts:
- Gift and Estate Tax Efficiency. With a Crummey trust, the donor has the option of paying the trust’s income taxes without those payments being considered gifts (assuming the trust is a grantor trust, which Crummey trusts almost always are). These tax payments are essentially gifts to the beneficiaries, who would otherwise be paying their own taxes, but they’re not considered gifts for gift-tax purposes.
- Creditor Protection. Because a Crummey trust is a separate legal person, it is generally not subject to liability for actions taken by the trust’s grantor or beneficiary.
- Duration. A Crummey trust can last for the beneficiary’s entire lifetime, so the entire trust value isn’t turned over to your kids when they turn 18 or 21.
- Control. Trusts allow people to put rules and conditions around how the money they transfer to a trust is used, or give someone (the trustee) discretion over when to make distributions. This prevents 22-year-olds from blowing the money they inherit on frivolous purchases or bad investments.
- Lower Income Taxes. It’s possible to modify a Crummey trust so that it is taxed as a non-grantor trust. By doing that, you can (a) avoid state income tax on the trust’s income if you/the grantor is located in a state with state taxes or (b) make distributions to the beneficiary so that the beneficiary, not the trust or the donor, pays the income taxes (which might make sense if the beneficiary is in a lower tax bracket).
Why Wouldn’t I Set up a Crummey Trust?
Crummey trusts do have one downside: cost. Traditionally, providers have charged $5,000-$15,000 for trust set-up, and then additional amounts to handle and track Crummey notices. Fortunately, with Valur, setting up a Crummey trust is free, and maintaining it is inexpensive.
Crummey Trusts vs. Outright Gifts
Making outright gifts to an individual to use annual exclusion is marginally cheaper than setting up a Crummey trust. It is also a little simpler — though nowadays setting up and administering these trusts is pretty simple! However, outright gifts don’t receive any creditor protection, are less tax efficient than Crummey trusts over the long term (because you can’t pay the individual beneficiary’s income taxes), and require you to forfeit all control over the gifted funds (so the beneficiary could spend all the money on a weekend in Vegas).
In contrast, Crummey trusts are highly estate-tax efficient, are protected from creditors, and can be structured so that the beneficiary can’t immediately blow all of the money in the account, even if the beneficiary is an adult.
If your beneficiaries are minors, outright cash gifts won’t really work anyways, since minors can’t open bank or brokerage accounts.
Crummey Trusts vs. Custodial Accounts
There are two big differences between Crummey trusts and custodial accounts. The first is that custodial accounts can only be set up for minors, so if your beneficiaries are adults, setting up a custodial account won’t be possible. The second difference is that custodial accounts terminate when the child reaches early adulthood — usually either age 18 or age 21. That means that when the child is college-aged, he or she will gain full access to, and control over, the money. The assets inside the custodial account receive some creditor protection, but once the funds are paid out to the beneficiary, they become subject to the beneficiary’s creditors.
Crummey trusts solve these problems. Anyone can be a beneficiary of one of these trusts, and Crummey trusts can last for a beneficiary’s entire life. As discussed above, Crummey trusts also have a feature that allows them to be treated as tax residents of low-tax states, potentially saving state income tax in some cases.
Custodial accounts can receive slightly more favorable federal income-tax treatment than Crummey trusts, thanks to the kiddie tax rules. As a result, setting one up may save you a few hundred dollars per year in income tax. On the flip side, custodial accounts may complicate your personal income-tax filings.
Crummey Trusts vs. 529 Plans
A 529 plan is a type of tax-advantaged account intended to help people save for educational expenses. Investment returns inside 529 plans are exempt from income tax, provided that the money goes toward education.
Both Crummey trusts and 529 plans use gift-tax annual exclusion. Sometimes people are unable to fund Crummey trusts because they’ve already used that year’s annual exclusion to fund a 529 plan for the same beneficiary. Other times, people have difficulty deciding between funding one type of account or the other.
It often makes sense to fund both. For example, you might set up a 529 plan and fund it when your children are babies, and then begin using annual exclusion to fund Crummey trusts once they reach kindergarten. In general, you don’t want to overfund a 529 plan since the funds are restricted to educational uses. What makes the most sense in any given situation will depend on the specific facts and circumstances.
The Bottom Line
Crummey trusts are a no-brainer for anyone who is worried about estate taxes. Thanks to their non-tax benefits, they can even make sense for people who aren’t particularly concerned about estate tax. If you’re interested in setting up a Crummey trust, you should set up time to chat with us here.
About Valur
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From selecting the right strategy to handling setup, administration, and ongoing optimization, we take care of the hard work so you don’t have to. The results speak for themselves: our customers have generated over $3 billion in additional wealth through our platform.
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