What is a Crummey trust?
Many people wish to make lifetime gifts to their children in order to save estate taxes. As long as a parent gives his child no more than $15,000 per year, the gifts will be entirely excluded from gift or estate taxes. (That $15,000 limit increases regularly with inflation.)
The problem with gifts so large is that children do not have the legal capacity, or in many cases the maturity, necessary to handle so much money. You can solve the issue of legal capacity by appointing yourself as custodian of the funds you have given your child (such as by making the gift subject to the Uniform Transfers to Minors Act), but under a custodial arrangement, the child obtains access to all of the money upon turning 21, or in some states 18. To many parents, this is still too young.
To keep the money out of a child's hands until he is, say, 28 years old, you must set up a formal trust. You would then make your gifts to the trust, and the trustee would invest the money. To conserve costs, you could even serve as trustee yourself. The trust documents would direct that the assets be distributed to the child when the child reaches age 28. Some people have the trust distribute the funds in steps: the child receives one-third when he turns 25, one-third when he turns 30, and the final third when he turns 35.
The one catch to all of this is that the $15,000 annual exclusion only applies to gifts in which the recipient has a "present interest" in the gift (as opposed to a "future interest"). In order to completely avoid gift or estate tax on the money you give to the child's trust, you must give the child some right that qualifies as a "present interest."
What qualifies as a present interest? Generally, the child has to have the right to take the money and spend it immediately. However, you can place significant restrictions on this right without losing the gift tax exclusion. A common method of doing so is to set up what is known as a Crummey Trust. It's named after the Crummey family, who set up such a trust. The IRS tried to deny them the annual gift tax exclusion, but they went to court and won.
A Crummey Trust does not give the child any rights to the income. It does, however, give the child the right to withdraw the amount of each gift for up to 30 days after each gift is made. Since the withdrawal right begins immediately after the gift is made, it is considered a present interest. If the child does not withdraw the gift within the 30 days, the withdrawal right lapses and the money remains in the trust until the child reaches the designated distribution age.
Of course, the parent must still convince the child not to withdraw the money during those 30 days. However, even if the child decides to withdraw the money, he can only withdraw the amount of the most recent gift, not the entire trust. And after that the parent can eliminate all future withdrawal opportunities simply by ceasing to make any more gifts. The property in the trust will still remain intact and growing until it's ready to be distributed.