Generation-skipping transfer tax consequences need to be taken into account.
College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to firstname.lastname@example.org.
In my August column, I compared 529 savings accounts with an alternative way of making gifts to minors, gifts to 2503(c) trusts. In my September column, I compared 529 savings accounts with gifts to Crummey trusts that are each established for a single beneficiary. Thus both my August and September columns discussed trusts that would only have a single beneficiary. A major limitation of these types of trusts is the inability to spray trust distributions among the group of beneficiaries. Thus if a 529 savings account is owned by one of these types of trusts and not all of the funds are needed for qualified higher education expenses of the beneficiary, a nonqualified distribution must be made either to the beneficiary directly or to the trust for future distribution to the beneficiary. Because of the restrictions in the trust, the beneficiary of the 529 savings account cannot be changed to another family member.
In my October column, I discussed another alternative way of making gifts to minors, gifts to a Crummey trust established for multiple beneficiaries, all of whom are children of the donor. A significant advantage of a shared Crummey trust for children is that if the trust owns a 529 savings account for one beneficiary, the beneficiary of the account later can be changed to another child.
This column will discuss shared Crummey trusts for grandchildren or more remote descendants. For a shared trust for grandchildren, generation-skipping transfer tax consequences need to be taken into account.
Gift Tax Annual Exclusion
Usually gifts to a trust do not qualify for the gift tax annual exclusion because the trust beneficiary does not have the "present interest" required to qualify for the gift tax annual exclusion. Typically, a trust beneficiary only has a future interest in the trust property. However, the case of Crummey v. Commissioner, 397 F.2d 82 (9th Circuit 1968) established that a present interest is created if the beneficiary of a trust has the right to withdraw contributions to the trust when made. Thus annual exclusion gifts to a Crummey trust will qualify for the gift tax annual exclusion.
A Crummey trust may have multiple beneficiaries, each of whom has a right to withdraw a portion of contributions made to the trust. For example, if Mother establishes a shared Crummey trust for her children, Alice, Atticus and Alex, the trust could provide that each child would have a right to withdraw a pro rata share of each contribution to the trust. Thus if Mother contributed $39,000 to the trust in 2009 (and made no other gifts to the children during the year), each child would have a right to withdraw $13,000 of the contribution and the entire contribution to the trust would qualify for the gift tax annual exclusion.
Tax complications arise, however, when the beneficiaries' rights of withdrawal lapse. When a beneficiary's right to withdraw a contribution lapses, the beneficiary is deemed to have made a gift to the trust to the extent the lapse in any year exceeds the greater of $5,000 or 5% of the trust assets. Thus in the prior example, if the trust was worth $100,000 or less, and assuming that the rights of withdrawal lapsed 90 days after the contribution to the trust was made, upon the date the rights of withdrawal lapsed, each beneficiary would be deemed to have made a gift to the trust of $8,000 ($13,000 less $5,000). As discussed in the September column, with a Crummey trust for a single beneficiary, gift tax consequences can be avoided by giving the beneficiary a power to appoint the trust assets upon his or her death. This solution, however, is generally not available with respect to a shared Crummey trust.
My October column discussed a number of possible strategies to avoid a taxable gift from each beneficiary to the trust upon the lapse of the beneficiary's rights of withdrawal. The most common solution to avoid a gift to the trust when a beneficiary's right of withdrawal lapses is to use "hanging powers." A "hanging power" is a provision in the trust that provides for the beneficiary's right of withdrawal to expire only at a rate that will not exceed the greater of $5,000 or 5% of the value of the trust in any given year. The hanging power thus can extend the time period during which a trust beneficiary can exercise a power of withdrawal. If, in a given year, a withdrawal beneficiary's share of contributions to the trust exceeds the $5,000 or 5% threshold, the amount in excess of such threshold will remain subject to withdrawal. In succeeding years, contributions to the trust may again exceed the $5,000 or 5% threshold, and the amount remaining subject to withdrawal will accumulate. As a result, the beneficiary may possess a power to withdraw assets from the trust for quite a long time, and the power may eventually involve a sizable amount of property. In time, however, due to growth in value of the trust or other factors, the annual contributions to the trust may be less than the $5,000 or 5% threshold. As a result, the accumulated excess amounts remaining subject to withdrawal will begin to decline and may eventually be reduced to zero.