Legal Definitions - Crummey power

A Crummey power is a specific right granted to a beneficiary of a trust, allowing them to temporarily withdraw a portion of any new contributions made to that trust. This right is crucial for tax planning, as it transforms what would otherwise be considered a "future interest" gift (which doesn't qualify for the annual gift tax exclusion) into a "present interest" gift. By giving the beneficiary a brief window to access the funds, the gift becomes eligible for the annual gift tax exclusion, allowing the person making the gift to avoid paying gift taxes on that amount, up to the annual exclusion limit.

Typically, the withdrawal right is for a limited amount (often tied to the annual gift tax exclusion amount set by the IRS) and for a short period, such as 30 or 60 days, after the gift is made. Beneficiaries usually choose not to exercise this power, allowing the funds to remain in the trust as intended, but the mere existence of the right is sufficient for tax purposes.

• Example 1: Funding a Grandchild's Education Trust

  Grandparents establish an irrevocable trust to save for their grandchild's future college education. Each year, they contribute $18,000 (assuming this is the annual gift tax exclusion limit) to the trust. The trust document includes a Crummey power. When the grandparents make their annual contribution, the grandchild is formally notified that they have 30 days to withdraw the $18,000. The grandchild, understanding the purpose of the trust, allows the 30-day period to expire without making a withdrawal. The funds remain in the trust for their education, and the grandparents' gift qualifies for the annual gift tax exclusion, meaning they don't have to pay gift tax on that amount.

  This illustrates a Crummey power because the temporary right of withdrawal by the grandchild makes the gift a "present interest," allowing the grandparents to use their annual gift tax exclusion, even though the money is intended to stay in the trust for future use.

• Example 2: Contributions to an Irrevocable Life Insurance Trust (ILIT)

  A couple sets up an Irrevocable Life Insurance Trust (ILIT) to hold a life insurance policy. Each year, they contribute funds to the ILIT to cover the policy's premium payments. To ensure these contributions are not subject to gift tax, the trust incorporates Crummey powers. When the annual contribution is made to the ILIT, the beneficiaries (their children) receive a notice informing them of their right to withdraw a portion of that contribution, up to the annual exclusion amount, within a 45-day window. The children, knowing the funds are meant to pay the insurance premium that will eventually benefit them, choose not to exercise this withdrawal right. The funds then remain in the trust to pay the premium.

  Here, the Crummey power allows the couple's contributions to the ILIT to qualify for the annual gift tax exclusion, making their premium payments gift-tax free, because the beneficiaries temporarily had the right to access the funds.

• Example 3: Gifts to a Special Needs Trust

  An aunt and uncle want to contribute to a special needs trust established for their niece, who has a disability. The trust is designed to supplement her care without jeopardizing her eligibility for government benefits. To make their gifts tax-efficient, the trust includes Crummey powers. When the aunt and uncle each contribute $10,000 to the trust, the niece (or her appointed guardian, if applicable) is notified that she has a limited time, say 60 days, to withdraw up to the annual exclusion amount from each contribution. The guardian, understanding the importance of the trust's purpose and the tax benefits, allows the withdrawal period to lapse. The funds remain in the trust to provide for the niece's supplemental needs.

  This example demonstrates how a Crummey power enables the aunt and uncle to make tax-free gifts to the special needs trust by converting what would be a future interest into a present interest, ensuring the funds are available for the niece's long-term care without immediate tax implications for the donors.