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Insurance, Crummey, and Grantor-Retained Interest Trusts

Insurance trusts, Crummey trusts, and grantor-retained interest trusts can solve issues that arise with an estate. Insurance trusts ensure that an estate meets its cash needs. Crummey trusts are designed to avoid gift taxes on transfers. Grantor-retained interest trusts allow the grantor, the person who creates the trust, to transfer property into a trust without losing the benefit of that property.

Insurance trusts: Funding the estate’s cash needs

Insurance trusts are used to ensure that adequate funds are available to pay the cash needs of an estate.

Sometimes the majority of a decedent’s estate is comprised of assets that have real value but cannot be readily transferred into a trust. For example, a decedent’s estate may include a company that he or she owned. In cases such as this, the estate may not have enough cash to cover the due taxes.

Insurance trusts use insurance policies and a small amount of cash as assets. The trust owns the insurance policies on the life of the grantor. When the grantor dies, the policies pay into the trust and money is then available to pay the debts of the decedent and the estate.

Use insurance trusts wisely. If the premiums have been paid by using the grantor’s annual exclusion from gift tax or some of his or her lifetime annual exclusion, the face value of the life insurance policies on the grantor’s death isn’t included in the grantor’s estate for estate tax purposes.

Crummey trusts: Avoiding the gift tax

In a Crummey trust, creating present interest — the illusion that the beneficiaries have the right to use a gift at the time it’s given — is crucial. This illusion allows the grantor to use the annual exclusion to eliminate any gift tax consequences.

There are certain rules and steps that must be followed to execute a Crummey trust successfully:

  1. Making the gift.

    The grantor transfers money equal to or less than the annual exclusion amount into the trust.

  2. Setting a time constraint.

    When the gift is made, the trustee sends a letter to all the named beneficiaries telling them that they have a right to withdraw some or all of the gift within a specified period of time.

  3. Failing to withdraw.

    The beneficiaries fail to withdraw from the trust during this period. The grantor, trustee and beneficiaries all understand that the money won’t be claimed. Consequently, their ability to do so lapses and the money remains inside the trust.

This ability of the beneficiaries to withdraw a gift at the time it’s made is called a Crummey power. Crummery power creates the present interest required for annual exclusion gifts. In a Crummey trust, the trustee is responsible for investing the cash. Distributions may be made to the beneficiaries in the future.

Grantor-retained interest trusts: Transferring with benefits

In grantor-retained interest trusts, the grantor gifts a property into a trust but keeps an interest — either the income from the property or the use of the property — for a specified period of time.

In these trusts, the interest is finite, and the transfer of property constitutes a gift. The grantor must file Form 709, a federal gift tax return. The gift tax value is the value of the property at the date of the gift, minus the value of the grantor’s retained interest.

Grantor-retained interest trusts come in many varieties including these:

  • Grantor-retained Income Trusts: The grantor transfers property into this trust but holds onto the income for a specified period of time. After this time, the beneficiaries receive the income.

  • Grantor-retained Annuity Trusts: The grantor transfers property into the trust and receives a scheduled and fixed payment based on a percentage of the initial value of the transfer.

  • Grantor-retained Unitrusts: The grantor transfers property into the trust and receives an annual payment from the trust for a specified period. The unitrust payment changes annually. It is based on an asset valuation done on a specific day each year.

  • Qualified Personal Residence Trusts: The grantor transfers a residence into the trust, retaining the right to live there, rent free, for a specified period. After this period, the property belongs to the beneficiaries and they can allow the grantor to remain in the residence at their discretion.

Seek advice when structuring grantor-retained interest trusts. If the trust isn’t structured correctly the IRS may disallow the gift transferred into the trust.

It’s very important when dealing with a qualified personal residence trust that the grantor pays the new owners market rent if he or she continues to live in the residence after the specified rent-free period ends and the beneficiaries take ownership of the property. Otherwise, the IRS may decide that the grantor never actually made the gift and therefore still owns the house.

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