A Crummey trust is a special kind of trust that is designed to retain the ability for a gift to the trust to be counted as an excluded gift for gift-tax purposes. The trust earns its name from the Crummey family because they were the ones to challenge the IRS in court and won.
In order for a gift to count as an excludable gift, the donee (typically the child) has to have a present interest in the gift. Getting the gift now is a present interest, and getting the gift, say, at age 35, would be a future interest.
The idea is that with each gift to the trust, you give the child a chance to withdraw the gift within a certain window of time. The withdrawal right that is available to the child right now satisfies the present interest requirement. If the child does not withdraw the gift, then the child loses the withdrawal right and the funds are safely managed by the trust, until the trust distributes the money to the child, and without incurring gift tax liability.
There are more complexities and choices to be made, particularly with whether you want to avoid gift-tax liability against the beneficiary. This is because each time the beneficiary does not withdraw the funds, you can think of it like the beneficiary giving a gift to the trust also. There are some complicated rules that deal with this aspect; but, generally, gifts less than $5,000.00 or 5% of the trust body can be excluded each year. You can also draft the trust so that even if you gave larger gifts, it would continue to exclude $5,000.00 or 5% each year. The disadvantage to this is that all the funds that have not yet been excluded will still be subject to withdrawal by the beneficiary.
What if the child withdraws the money? You simply don’t make any future gifts into the Crummey trust. Also, for added peace of mind, only the current gift is subject to the withdrawal right, not past gifts. The past gifts will continue to be managed according to the terms of the trust. Thus, if you have a child that you don’t particularly trust, you can make more frequent smaller gifts instead of a single large gift to the trust so that if the child does exercise the right, they only withdraw the smaller gift instead of a larger gift.
Crummey trusts can be wonderful tools to use to transfer and manage wealth; but, they need to be drafted with precision. I highly recommend using a competent lawyer for any such complex trust.