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529 Plans Versus Shared Crummey Trusts for Children

There vehicles are another option for funding college expenses.

Susan T. Bart, 10/23/2009

College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to advisorquest@morningstar.com.

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. These types of trusts by definition can only make distributions to the single beneficiary during such beneficiary's life. These types of trusts do not permit distributions among a group of beneficiaries for a particular purpose, such as paying education expenses. Further, although both the 2503(c) trust and a Crummey trust for a single beneficiary could own a section 529 account for the trust beneficiary, the beneficiary of such a trust-owned 529 account could not be changed. Thus a major limitation of these types of trusts is the inability to spray trust distributions among the group of beneficiaries.

This month I will discuss 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. I am limiting this column to discussing shared Crummey trusts for children to avoid confusion; where a shared Crummey trust is established for grandchildren or more remote descendants, the complicated generation-skipping transfer ("GST") tax consequences need to be taken into account. A future column will discuss shared Crummey trusts for grandchildren.

Background
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.

There are 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. One possible strategy is for the donor to initially fund the trust with a $260,000 taxable gift. Because 5% of $260,000 is $13,000, the amount of the expected annual gifts to the shared Crummey trust, the lapse of a beneficiary's withdrawal right would not exceed 5% of the value of the trust assets, and the beneficiary would not be deemed to be making a gift to the trust (assuming the value of the trust assets did not dip below $260,000). To implement this strategy, the donor would have to be willing to make a taxable gift of $260,000 to the trust. If the donor still had an amount equal to at least $260,000 of his or her $1,000,000 lifetime exemption available, there would be no gift tax cost to initially funding the trust in this manner. However, to the extent the donor had already utilized his or her $1,000,000 lifetime exclusion, a gift tax would be imposed on the $260,000 gift to the trust (currently at a rate of 45%). Further, many clients may not have the ability initially to fund the trust so generously.

A second strategy is to have cascading rights of withdrawal so that when a beneficiary's rights of withdrawal lapse and the beneficiary is deemed to have made a gift to the trust, the other beneficiaries have new rights of withdrawal over the deemed gift. This is a very complicated solution and to my knowledge has never been tested with the IRS.

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