Money Vocabulary - The Crummey Letter
Just follow the Yellow Brick Road
In January we are often dealing with fallout from holiday gifts – returning items to stores, creating space, putting things away, and sending the Crummey Letters. For those new to having multi-generational wealth, learning the rules around gifts can be a “We’re not in Kansas anymore” experience. In a previous Money Vocabulary post, I wrote about how gifts of a certain size become taxable. That’s just scratching the surface. Gifts are complex, gifts have consequences, and they can require follow-up steps that can seem like a burden.
There are two “freebies” in the gift and estate tax code: (1) the annual exclusion and (2) the lifetime exemption. The annual exclusion seems very simple on its face – you can give anyone $18,000 a year in 2024 without paying gift tax. However, circumstances rarely present where such a straight-forward exchange makes sense particularly with young recipients.
For example, if I want to give my hypothetical 18-year-old cousin $18,000 ($36,000 if my husband consents to gift split) at their high school graduation, what are the odds I like how they spend the money? With the funds in their hands, they are free to do as they please. Only their own financial savviness, or following advice from a wise elder, would steer them towards spending it well or saving it for the future.
Guidance towards the “right” answer may work for some recipients. Understanding that the gifts could stop if they are deemed wasted could also work. Indeed, gifts can be a great way to learn how to make mistakes with money if the sum isn’t too substantial.
For some, gifts need structure or they become more of a burden than a blessing. Giving a gift in trust can make sense for a variety of reasons. A trust can allow for professional management of assets and control over how the beneficiary benefits from the gift (like not spending it on substances that could hurt them). Consistent annual gifting can build to a significant sum over time with proper care. Plus, there can be liability protection provided by a trust.
When the beneficiary doesn’t have control over the assets and there are rules to be followed, is the gift really a gift? The IRS is not blind to the difference between the restrictions of a gift in trust and handing someone an envelope of cash. Fortunately, the IRS also sees the realistic limitations of unfettered benevolence.
To qualify for the annual exclusion, the recipient must have a “present interest” in the gift. That is, they must have at least some degree of access to it. When gifts are made to a trust, if the annual exclusion is to be used, the trust must allow for the beneficiary to be able to withdraw the funds for a period. This is often 30 days but sometimes longer. After that period, the ability to withdraw lapses (The provisions around lapses are complex and can be designed several ways. This is where having a knowledgeable attorney who specializes in trusts and estates on your team is a must.) Furthermore, the beneficiary must be made known they have this access and that a gift was made. Enter – the Crummey Letter.
The Crummey Letter, or Crummy Notice, is a letter sent by the trustee to the trust beneficiary informing them of the contribution made to the trust and their ability to withdraw the funds. The beneficiary signs the letter acknowledging receipt and the trustee holds on to it for their records should the use of the annual exclusion ever be challenged. It’s a formality that allows gifts made in trust to achieve the level of “present interest.”
The Crummey Letter is also a teachable moment.
For example, assume I want my hypothetical 18-year-old cousin to have funds for a down payment on a house in 10 years. Instead of making a large gift at the time of purchase, I start putting the annual exclusion amount into a trust. If the trust is not invaded, the principal can grow with fresh capital added each year. In this case, some things I might also discuss with my cousin:
· Why supporting them in this way is important to me. What I hope this help means to them.
· My own experience with buying a house and the housing market.
· How the funds are invested and annual performance.
· Compound interest and expectations for growth over time. The opportunity cost of exercising their withdrawal right now is the appreciation of these funds if otherwise left in the trust. This may jeopardize the down payment goal.
· How trusts work and how to be a beneficiary. This could be particularly important if they are or will be beneficiaries of other trusts.
Of course, my cousin could exercise the withdrawal right anyway. But the odds of them signing the notice and not withdrawing the funds are significantly higher than them handing the funds properly on their own over the next 10+ years.
For those new to them, sending Crummey letters and getting trust beneficiaries to sign them is, well, crummy. So much of estate planning for ultra-affluent families is simply knowing the steps to the IRS’s dance. This is very much a step in the dance. Fortunately, the dance gets easier with practice, and becomes more like walking down a familiar, well-marked path. While you’ll never be joyfully sending Crummeys like Dorothy skipping down the Yellow Brick Road, it’s well worth the nuisance to take advantage of the annual exclusion in a way that makes sense.