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How to give assets to your grandchildren (but keep control)

Many older people would like to make significant gifts to their grandchildren, in order to help them and in order to reduce the size of their own estate for tax purposes. But they also worry that the grandchildren won’t be able to handle large sums of money.

The good news is that you can give each of your grandchildren up to $13,000 a year without incurring any gift tax. If you’re married, your spouse can also give each grandchild up to $13,000 a year.

The bad news is that young people are notoriously immature with money, and simply handing a young adult a big windfall won’t necessarily result in the wisest and most cautious financial decisions.

However, there are ways that you can “give” money to grandchildren for tax purposes, but retain control over it at the same time.

If your grandchildren are minors, then you can’t transfer assets to them directly. In most cases, you’d need to transfer assets to a custodial account, where an adult custodian manages the account for the child’s benefit.

That’s great – but the problem with a custodial account is that the moment the minor reaches adulthood (usually at age 18 or 21), he or she will own the account completely. The brand-new adult can immediately withdraw all the money and spend it on anything he or she feels like.

A better solution is to put the money into a trust. With a trust, you can specify that your grandchildren won’t have access to the assets until they are old enough to handle them responsibly. For instance, a trust might end when a grandchild turns 28. Or a grandchild might get a third of the assets at age 25, a third at 30, and the rest at 35.

Setting up a trust for a grandchild is a little tricky, though. While you (and your spouse) can directly give an adult grandchild $13,000 a year without paying gift tax, the same rule doesn’t apply if you put the money in a trust. That’s because you’re not really “giving” the grandchild the money; you’re just giving him or her a future interest in the money. The law says that to avoid the gift tax, you have to give a “present interest” in the money.

So here’s the solution: The trust is set up so that whenever you make a contribution, the grandchild has the right to withdraw that contribution for the next 30 days. If the grandchild does nothing, the money stays in the trust and the grandchild can no longer access it directly. But the contribution still counts as a “gift” for tax purposes.

Of course, this creates the risk that the grandchild will withdraw the money during the 30 days. However, you can make it clear to the grandchild that if he or she does so, you won’t make any more contributions – which should be a very strong deterrent.

This type of trust is known as a “Crummey” trust. Despite the funny name, there’s nothing wrong with a Crummey trust. It was named for D. Clifford Crummey, the man who pioneered the idea back in the 1960s.

To make things easier, a single Crummey trust can be created to benefit multiple grandchildren.

Here are a few things to consider if you’re thinking about a Crummey trust:

  • You can be the trustee if you want. But if you (or your spouse) is the trustee, you’ll need to be careful in the way the trust is set up and administered, because if it’s not done properly, the assets in the trust may be included in your taxable estate if you pass away.
  • You’ll want to decide who should pay the tax on the trust’s income. You can set up the trust such that the income will be taxable to the trust, to the grandchild, or to you.
  • The trust’s assets will typically be considered as assets of the grandchild for purposes of calculating college financial aid awards.
  • Any time you make gifts to grandchildren, you need to plan around something called the “generation-skipping transfer tax.” This is a special tax designed to prevent people from avoiding gift and estate taxes by making gifts that skip generations. You may be able to plan around it and avoid it – depending on your circumstances – but you’ll need to take it into account.
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