Irrevocable living trusts

If your goal in establishing a trust is to remove assets from your estate, you may choose to establish an irrevocable living trust. You relinquish control over the assets, except that you can specify the way in which you want the trustee to manage and distribute them. You also give up any income that the assets in the trust generate. But if those assets increase in value after they go into the trust, those gains aren’t part of your taxable estate and they don’t count against your lifetime tax-free gift limit of $1 million. In fact, if you gradually fund the trust with annual gifts valued at or below the gift exclusion — $12,000 in 2008 — you can avoid gift taxes entirely.

One example is a trust you set up to hold gifts to your children or grandchildren. You can arrange to distribute the trust principal in one lump sum, perhaps at age 30, or in increments — say one-third at age 25, one-third at 30, and the balance at 35. Such a trust may be preferable to putting assets in a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account. In that case, the beneficiary has the right to withdraw the assets at the age of majority (often as early as 18 or 21, depending on the state).

An irrevocable trust set up with Crummey lets you claim the annual gift exclusion so that you can avoid gift taxes. But so that gifts to the trust qualify as gifts of “present interests,” the beneficiary does have the right to withdraw any annual gift for up to 30 days after you make it. For the trust to work as planned, the parent or grandparent must persuade the child not to withdraw the money during the 30-day period.

Income vs. Principal
In most jurisdictions there are specific legal definitions of what constitutes trust income and principal. (For example, are gains from the sale of trust assets income or additions to principal?) In general, income is the earnings on the trust’s investments, such as bank interest, stock dividends, or rent on real estate properties. Principal is the value of the trust’s assets — not including anything considered income. Most trusts specify when and how the trustee is to distribute trust income and principal to the beneficiary.

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