A Gift Trust allows you to make gifts to your children or other beneficiaries, protect those gifts from the beneficiaries or their creditors, and still utilize your annual Gift Tax exclusion.
Gifting is a great estate planning strategy. A gift provides a specific monetary benefit to the recipient, and every dollar gifted is removed from the donor's taxable estate. However, for some recipients, an outright gift may do more harm than good.
The problem with making an outright gift is that the recipient can do whatever they want with it. For some people (gamblers, those with substance abuse issues, etc.) an outright gift can enable destructive behavior. For others (minors, inexperienced twenty-somethings, poor money-managers) an outright gift is just a bad idea. Still further, even responsible recipients could be involved in a car accident, or face an involuntary lawsuit that would put the gift in jeopardy.
Fortunately, gifts made to a trust can provide the monetary benefit, for the right reasons, and be protected from the beneficiaries and their creditors. But gifting to a trust can have tax consequences. Each person can gift $14,000 per person per year (and married couples can gift double). This is called the Gift Tax Annual Exclusion. In order to be eligible for this exclusion, the gift must be of a present interest. This means that the recipient must have the immediate ability to use the gift. Most trusts do not give that ability to the beneficiaries.
Luckily, there is a technique that allows us to utilize the annual exclusion within the trust context. The technique involves sending letters to beneficiaries every time that a gift is made to the Gift Trust. The letters grant the beneficiaries a temporary right to withdraw those gifts, which renders the gifts into present interests eligible for the annual exclusion. The withdrawal powers are called Crummey powers, and the letters are Crummey letters, because the first person to do this was named Crummey, and he was the plaintiff in a Tax Court case on the issue.
Of course the donor would be sure to explain to the beneficiaries that they should not exercise their withdrawal power. So it is said that, "The first exercise of a Crummey power is the last exercise of a Crummey power."