What Is a Gift in Trust?
A gift in trust is a special legal and fiduciary arrangement that allows for an indirect bequest of assets to a beneficiary. The purpose of a gift in trust is to avoid the tax on gifts that exceed the annual gift tax exclusion limit. This type of trust is commonly used to transfer wealth to the next generation.
- Gifts in trust are commonly used to pass wealth from one generation to another by establishing a trust fund.
- Typically, the IRS taxes the value of a gift being transferred up to the annual gift tax exclusion amount.
- A gift in trust is a way to avoid taxes on gifts that exceed the annual gift tax exclusion amount.
- One type of gift in trust is a Crummey trust, which allows gifts to be given for a specific period, establishing the gifts as a present interest and eligible for the gift tax exclusion.
- A drawback to a gift in trust is when it's established without limitations, allowing a beneficiary, such as a child, to withdraw large amounts, jeopardizing the fund's financial viability.
Understanding a Gift in Trust
Gifts in trust are commonly used by parents or grandparents who want to establish a trust fund for their children or grandchildren. Establishing a trust is an estate planning strategy that can be used to pass assets or wealth from the grantor—the owner of the assets creating the trust—to a beneficiary who receives the wealth.
The assets can be transferred based on the grantor's wishes, meaning limitations can be established so that the recipient can access the money only when the stipulated instructions outlined in the trust have been met. For example, a parent might establish a trust in which the funds can't be accessed by the child until their 21st birthday.
Annual Gift Tax Exclusion Amount
Typically, the Internal Revenue Service (IRS) taxes the gifting of assets from one person to another. However, the gift tax is only triggered if the value of the asset being transferred is more than a specific amount called the annual gift tax exclusion amount. The annual exclusion amount for gifts is $16,000 for calendar year 2022 and $17,000 for 2023.
A gift in trust is a viable method to avoid taxes on gifts that exceed the annual gift tax exclusion limit. Gift givers can give gifts in excess of the annual exclusion without paying taxes by establishing a special type of trust, such as a Crummey trust. A gift to a Crummey trust allows the beneficiary to withdraw the gift assets for a limited time, which makes the gift considered to be a present interest and eligible for the gift tax exclusion. If the gift did not have these limited-time withdrawal rights, it would be considered a future interest and be subject to gift taxes.
For example, the trust could be set up so that the beneficiary can make withdrawals within a set time period, such as within 60 or 90 days. After that, the gift funds held in the trust fall under the stipulated withdrawal rules as set by the trust's grantor. In our example, let's say the parent designates that a child can't access trust money until they turn 21. Even if the child decides to tap into the trust immediately, they only have access to the most recent gift, as all previous gift funds remain protected within the trust account.
A Crummey provision can also be housed within another type of trust. For example, traditional life insurance trusts often contain a Crummey provision.
Advantages and Disadvantages of a Gift in Trust
In addition to tax benefits, a gift in trust is one method of establishing a financial cushion for future generations. Transferring wealth from one generation to the next via a will or other means of inheritance is a complicated endeavor, both logistically and emotionally. At the same time, these rules can bring enormous benefits to individuals, families, and communities. Understanding the nuances of gifting can bring added value to both grantors and beneficiaries.
One potential drawback to a gift in trust is that providing beneficiaries—in particular, children—with immediate access to sizable sums may jeopardize the fund's ability to accumulate long-term wealth. Some families bypass this by setting restrictions, such as limiting the amount or frequency of withdrawals or ending future gifts to recipients who withdraw funds immediately.