» Withdrawal Rights

A "Crummey" Trust is simply a trust containing withdrawal rights. The name comes from a taxpayer who used withdrawal rights in an irrevocable trust in the 1960's. The IRS challenged him, and he was forced to go to court. Mr. Crummey won his case--the court held that granting withdrawal rights was a valid estate planning technique. Since that time, Crummey withdrawal rights have become widely used in estate planning.

Normally, gifts to a trust do not qualify for the $19,000 (2025 amount) "present interest exclusion" from federal gift taxes (described below). However, when the trust beneficiaries have withdrawal rights, gifts to the trust will qualify for the exclusion.

Under the Internal Revenue Code, the so-called "present interest exclusion" allows every individual to make gifts of up to $19,000 per year per recipient without any gift tax concerns. The exclusion is computed on a per donor (gift-giver) per donee (gift recipient) basis. So, for example, a married couple with three children can make tax free gifts of up to $114,000 per year to their children (6 x $19,000). Gifts in excess of the exclusion--or gifts that do not qualify for the exclusion--count against the donor's lifetime federal gift tax exemption amount, which is currently $13,990,000 (2025 amount).

Withdrawal rights give each beneficiary a limited window of time to withdraw up to his or her pro rata share of gifts made to the trust each year (not to exceed $19,000 per year). Beneficiaries with withdrawal rights may either exercise the right (i.e., take the money) or choose not to, in their own absolute discretion. However, if the beneficiary is a minor, then his or her parent or guardian exercises the right (or elects not to exercise the right) for the beneficiary. For tax purposes, a gift to a trust with withdrawal rights is treated like a direct gift to the beneficiaries who have the withdrawal rights. As a result, the gift qualifies for the present interest exclusion.

Generally, there are two basic types of withdrawal rights that can be included in a trust agreement: "full" withdrawal rights and "5 & 5" withdrawal rights. A beneficiary with a "full" withdrawal right has the right to withdraw all or any part of his or her pro rata share of every gift, up to the $19,000 annual exclusion. A full withdrawal right thus takes full advantage of the gift tax annual gift tax exclusion. So, in the above example, if a husband and wife with three children give $114,000 to a trust for their children, and if the children all have full withdrawal rights, each child has the power to withdraw up to $38,000, and the full $114,000 is covered by the parents' combined exclusions.

A beneficiary with a 5 & 5 withdrawal right is generally limited to withdrawing the lesser of the $19,000 annual exclusion amount and the "5 & 5" amount. The 5 & 5 amount is the greater of $5,000 or 5% of the value of the trust on the last day of the year in which the gift is made. Also, while the present interest exclusion is computed on a per donor per donee basis, the 5 & 5 amount is computed on a simple per donee basis: each donee gets only one 5 & 5 amount per year even if there are multiple donors.

So, returning to the above example, if a husband and wife with three children give $114,000 to a trust for their children (and that is the only amount in the trust), and if the children all have 5 & 5 withdrawal rights, the 5 & 5 amount limits each child's withdrawal right to $5,700, and only $17,100 of the gift (3 x $5,700) qualifies for the exclusion; the remaining $96,900 counts against the parents' respective $13,990,000 lifetime gift tax exemption amounts. However, if the value of the trust (including the $114,000 gift) were at least $760,000, then the 5 & 5 amount would not limit the withdrawal right (because 5% of $760,000 is $38,000), and the full $114,000 would qualify for the exclusion.

All withdrawal rights eventually terminate or "lapse." The exact timing and nature of the lapses will be described in detail in the trust agreement. However, as a general rule, a beneficiary's withdrawal right--other than a "hanging" withdrawal right (described below)--will lapse somewhere between 30 and 90 days after the beneficiary receives notice of the gift.

A "hanging" withdrawal right (a/k/a "hanging power") differs from an ordinary withdrawal right in the manner of its lapse. Like an ordinary withdrawal right, a hanging withdrawal right will generally be fully exercisable for 30 to 90 days. Unlike an ordinary withdrawal right, a hanging withdrawal right does not lapse completely at the expiration of the stated term; instead, it lapses only to the extent of the 5 & 5 amount (discussed above). The excess amount, if any, does not lapse until the following year (or later). Further, all lapses in a single calendar year are aggregated and must stay within the 5 & 5 limit.

For example, if a $10,000 gift was made to a trust in year 1 and the beneficiary had a 5 & 5 withdrawal right, $5,000 of his withdrawal right would lapse in year 1 and the remaining $5,000 would not lapse until the following year. If a second $10,000 gift was made in year 2, no portion of this second gift would lapse during year 2 because the first gift's lapse would have already exhausted the 5 & 5 limit on lapses in year 2. If this scenario repeated for several years the total amount subject to withdrawal could be substantial.

On the other hand, if (or when) the value of the trust becomes large enough or the donors stop making gifts to the trust, the lapses would catch up with the gifts and, eventually, the withdrawal rights would lapse completely. For instance, if a trust's only asset was a $1,000,000 life insurance policy insuring the life of the grantor, the 5 & 5 amount would probably be $5,000 during the grantor's life (assuming the cash value was $100,000 or less) but in the year of the grantor's death--when the $1,000,000 proceeds would be received--the 5 & 5 amount would increase to $50,000. As a result, the outstanding withdrawal rights would begin lapsing at a rate of $50,000 per year instead of $5,000 per year.