In most cases, a trust set up for a minor does not qualify for annual gift tax exclusions. However, a certain type of trust called a “Crummey trust” offers estate planning and taxation benefits to the donor. A Crummey trust enables the donor to set conditions such that the trust funds may only be distributed for a certain type of expense, such as education expenses as long as certain conditions are met by the trustee. Crummey trusts can be a valuable tool for parents and grandparents to make gifts to minors and take advantage of gift tax exclusions. Any generation-skipping trust can be turned into a Crummey trust. To accomplish this, certain administrative procedures need to be established. Specifically, withdrawal powers must be added and “Crummey letters” sent every year to beneficiaries.
The primary advantage of Crummey trusts for making gifts to minors is the flexibility it offers donors in terms of financial planning, estate planning, and setting conditions on fund distribution. These trusts offer greater flexibility in the timing of distributions, as well, but the beneficiary must be given the right to withdraw annual exclusion gifts in order to qualify for the federal gift tax annual exclusion.
Generally, trust property can be comprised of a wide range of types of assets and may be invested in any manner, including 529 accounts, stocks, bonds, mutual funds, partnership or LLC interests, life insurance, and real estate holdings. A donor can establish a shared Crummy trust to benefit multiple beneficiaries, such as grandchildren, and distributions to these beneficiaries do not have to be equal. Finally, distributions can be made for purposes permitted by the trust, such as education expenses, without adverse income tax consequences.
The main disadvantage of a Crummey trust is the relatively complicated administrative requirements. For example, if the Crummey letters are not sent annually offering beneficiaries the right of withdrawal for a 30-day window, the trust may lose it status as a Crummey trust. The donor must designate a trustee other than the donor in order for the assets in the trust to be removed from the donor’s estate. Unlike 529 accounts, Crummey trust beneficiaries must report trust assets on financial aid applications, which could adversely affect their qualifications for financial aid. Finally, Crummey trust beneficiaries may exercise their right of withdrawal, which may not be what the donor intends.
Despite these administrative complications, which an attorney can help manage, a Crummey trust can be a very powerful tool for funding education and for a donor’s estate planning.
A 529 Plan is specifically designed to help families save for higher education expenses. These are investment plans operated by individual states that allow contributions to a designated beneficiary. As with UTMAs, there are both advantages and disadvantages to using 529s to make gifts to minors.
An advantage of a gift to a 529 account is that it can qualify for the $13,000 gift tax annual exclusion ($26,000 for a married couple). Additionally, donors may make a lump sum contribution equal to five years worth of qualifying donations and then prorate this contribution over the course of five years. Another advantage for Illinois residents is that state income taxes deductions are available for 529 contributions. Finally, distributions from the 529 account are tax-free when used for qualified education expenses.
The disadvantages of the 529 plans pertain to their relative lack of flexibility. These accounts can only accept cash, whereas custodial accounts and trust can hold a wide range of properties and investments. There is a 10% penalty for non-qualified withdrawals, and donors have far less control over investment decisions than they do with trust accounts; the investments are limited to plans offered by particular states.
This type of tool for gifting assets to minors can be established under the Uniform Transfer of to Minors Act (“UTMA”). Through UTMA, a donor establishes an account for a minors benefit and names a custodian. This custodian can invest funds and use them for education, medical care, support, and other benefits for the minor. There are some benefits to such custodial accounts, but they may not be the most effective vehicle for maximizing the benefits to the minor or to your own estate planning.
The main advantage of the custodial account is its relative simplicity. There is no trust to create and no separate tax return to file. The account would most likely be taxed at the minor’s tax bracket, which is likely lower that parents’ or a trust’s tax bracket. Also, it is possible to hold almost any kind of property in an UTMA account.
One of the main disadvantages of a custodial account is the loss of control over how the assets may be distributed. Upon reaching 18 or 21 depending on the state (in Illinois the “age of termination” for an UTMA account is 21), the assets in the account belong to the beneficiary to spend at his or her own discretion. Of course, the beneficiary may or may not decide to spend the assets on higher education expenses. Also, if the custodian is a parent, and the parent dies, the property in the UTMA account is taxable in the parent’s estate.
With the beginning of a new school year comes the excitement of new teachers, new shoes and backpacks, new friends, and the hope that this year will be the best one yet. Depending on the kid, it may come with a little bit of anxiety and the bittersweet farewell to (relatively) lazy summer days. With my own children it seems that the anxiety becomes a little more pronounced as they get older. For parents and grandparents, the new school year also comes with the reminder that, regardless of the ages of your children or grandchildren, the cost of higher education looms ever larger on the horizon.
Fortunately there are some financial planning and estate planning tools that can help ensure that your family members can avoid being weighed down too heavily by student loans. Some of these tools also offer benefits to your estate. When employed properly, the vehicles you can use to make gifts to minors can reduce the value of your estate and remove future appreciation from the estate, thus making it subject to lower estate taxes. Income-generating gifts you provide to minors may also be taxed at a lower rate because the minor beneficiary may be in a lower tax bracket.
Making an outright gift of cash or other assets, however, won’t enable you to take advantage of these estate planning benefits. In general, there are three types of tools that can provide taxation benefits when making gifts to minors for the purposes of their education. These are custodial accounts, 529 plans, and trusts.
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The information on this website may address some questions, but is not intended to be a comprehensive analysis of the topic or legal advice.
Independent tax and legal advice is recommended.
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