Crummey Power

Theodora Ashgrove contributes $40,000 this year to an irrevocable trust for her two grandchildren. The trust instrument gives each beneficiary the right, for 30 days following each contribution, to withdraw his or her share of that contribution. Her adviser explains that this CRUMMEY withdrawal power exists in order to:

1. A.Remove the trust assets from the grandchildren estates for generation-skipping tax purposesThe generation-skipping analysis depends on allocating GST exemption, not on the withdrawal power.
2. B.Convert what would otherwise be a gift of a future interest into a gift of a present interest, so the contributions can qualify for the annual gift tax exclusionCorrect. Present-interest status is the sole reason for the withdrawal window.
3. C.Make the trust revocable, so that Theodora can recover the funds if she later needs themThe trust remains irrevocable. The withdrawal right belongs to the beneficiaries, never to the grantor.
4. D.Shift the income tax liability of the trust to the grandchildren whether or not income is distributedTrust income taxation depends on distributions and the grantor trust rules, not on a Crummey power.

Why: The annual gift tax exclusion is available only for gifts of a PRESENT interest, meaning the donee has an immediate, unrestricted right to enjoy the property. A contribution to a trust whose distributions are deferred is a future interest and would not qualify. Granting each beneficiary a temporary right to withdraw the contribution creates the present interest, so contributions up to the annual exclusion amount per beneficiary escape gift tax and use no lifetime exclusion. The power lapses if not exercised, and the assets stay in the trust.

Ottoline transfers cash to her irrevocable life insurance trust each year so the trustee can pay the premium on a policy the trust owns. Her attorney wants each transfer to qualify for the annual gift tax exclusion. What must the trust provide?

1. A.Naming Ottoline as trustee so she controls the timing of distributionsIncorrect. Retaining that control would give her incidents of ownership and cause estate inclusion, and it still would not create a present interest.
2. B.Crummey withdrawal powers, giving each beneficiary written notice and a limited right to withdraw the contributionCorrect. A Crummey power converts a future-interest gift into a present interest, which is what the annual exclusion requires.
3. C.A provision making the trust revocable for the first 30 days after each contributionIncorrect. Revocability would pull the policy back into her estate and defeat the entire purpose of the trust.
4. D.A spendthrift clause barring beneficiaries from assigning their interestsIncorrect. A spendthrift clause protects beneficiaries from creditors but does nothing to create a present interest.

Why: The annual gift tax exclusion is available only for gifts of a PRESENT interest. A gift into a trust is normally a future interest, because the beneficiaries cannot touch it now. The standard fix is a CRUMMEY power: each beneficiary receives written notice of the contribution and a limited window in which to withdraw his or her share. That withdrawal right converts the gift into a present interest and makes the annual exclusion available, even though beneficiaries in practice let the window lapse.