A gift trust is a legal entity that allows a person or couple to give their children, grandchildren, or other loved ones gifts of money, property, and other assets through a trust, instead of giving the assets to them directly. This article explains what a gift trust is, how it works, and the limits on how much money can be put into it each year, all at once, or over a lifetime. It then describes how to set up a gift trust.
What is a gift trust?
A gift trust is a legal entity that allows a person or couple to give their children, grandchildren, or other loved ones gifts of money, property, and other assets through a trust, instead of giving the assets to them directly. At least some of these assets are usually distributed during the trust creator’s lifetime, but the trust can continue on after their death.
Gift trusts are often used as a way of transferring wealth to the next generation in phases instead of all at once. This allows the person giving the gifts to watch them be enjoyed while they are still alive. A gift fund also reduces estate taxes and probate fees.
Gift trusts are irrevocable, meaning that they cannot be changed or ended. The person who creates the trust (known as the trustor, grantor, or settlor) cannot change their mind about who receives the gifts or any of the conditions that those people need to meet in order to receive the money. They also cannot take back any of the money or other assets if they run into a financial emergency.
How does a gift trust work?
Once a gift trust is created, the trustor or trustors can start putting gifts in it. Common gifts are money, property, vehicles, and investments. The trustee then distributes these gifts to the beneficiaries according to the conditions of the trust.
For example, a couple may create a gift trust for their children when the children are still in their teens or early 20s. They may put in a condition that the children only start receiving a portion of the gift trust assets when they turn 25. On each child’s 25th birthday, the trustee will distribute the stated assets to the beneficiary.
The trustor(s) can add gifts every year, put in a large amount of money or other assets all at once, or do both.
How much can be put into a gift trust every year without being taxed?
The IRS allows each U.S. citizen or resident to give a certain amount as a gift each year without being taxed for it. This is called the annual gift tax exclusion, and it varies each year. For example, in 2022, the amount was $16,000. In 2023, it will be $17,000. 1
This means, for instance, that in 2022, a mother could give her son a car worth $16,000 without being taxed—or the mother and father together could give their son a car worth $32,000 without being taxed.
The IRS taxes the person who gives the gift, not the person who receives it.
However, the annual exclusion only applies to gifts that can be used and enjoyed right away by the person receiving them. For this reason, the gifts given into a gift trust technically do not count, and they are considered taxable. To avoid this, the estate planning lawyer will usually set up something called Crummey powers to make contributions to the gift trust eligible for the annual exclusion. Crummey powers are named after Clifford Crummey, a wealthy man who, in the 1960s, wanted to create a trust fund for his children while still getting tax benefits.
How much can be put into a gift trust all at once or in a lifetime?
The IRS allows a U.S. citizen or resident to give gifts equal to $12.06 million in their lifetime without being taxed. This is called the gift tax lifetime exemption. The first $16,000 (or other annual exclusion amount) that is given each year doesn’t count toward this total.
Because of the lifetime exemption, a person or couple can put large amounts of money into a gift trust without being taxed. For example, they could transfer the title to a $500,000 boat over to the trust, with their child as the beneficiary, and they wouldn’t pay gift taxes even though the amount is well over the annual gift tax exclusion.
However, anyone who gives a gift worth more than the annual exclusion amount has to report the gift to the IRS using Form 709 when they file their taxes.
How does the estate and gift tax work?
Gift taxes and estate taxes are counted together. The total amount of $12.06 million that can be given without being taxed applies to both gift taxes and estate taxes in combination. Gift and/or estate taxes will have to be paid if the total amount given as gifts in a person’s lifetime, minus the annual exclusion amount discussed previously, plus the total amount that their estate is worth when they die, equals more than $12.06 million.
For example, if a person gave $6 million into a gift trust (or as direct gifts) over their lifetime, and their estate is worth $5 million when they die, their estate or heirs will pay no gift or estate taxes, because the total equals only $11 million. However, if the person gave $10 million into a gift trust (or as direct gifts) and their estate is worth $5 million when they die, gift or estate taxes will be owed, because the total equals $15 million.
How does a gift trust lower estate taxes and probate fees?
Like other kinds of trusts, a gift trust lowers estate taxes by transferring ownership of the trustor’s money, property, or other assets from them to the trust. This means that when the trustor dies, whatever assets are in the gift trust are not taxable, because they no longer belong to the trustor.
Similarly, probate fees only apply to assets that belong to a person’s estate when they die. The assets in a gift trust do not belong to a person; they belong to the trust.
How can a gift trust be set up?
A person who wants to create a gift trust will work with an estate-planning lawyer. They decide on the beneficiaries and any conditions the beneficiaries need to meet before they can withdraw the money. For example, they might say that their granddaughter needs to turn 18 before she receives any of the money from the gift trust. Or they may say that their son needs to work for five years in a certain occupation before he can withdraw any money from the trust.
The trustor and lawyer will also name a trustee (or more than one trustee). This is the person who manages the trust and makes sure the assets are distributed to the beneficiaries in a way that follows the conditions in the trust document. Because gift trusts are irrevocable and complex, experts recommend making the trustee a professional trust manager or a trust administrator from a financial institution.
Assets and liabilities
Asset protection trust
Creating legal documents
Engaging an attorney
Estate and inheritance taxes
Financial plans versus estate plans
Life insurance trust
Overview of estate plans
Overview of trusts
Protecting assets from mishandling
Protecting assets from taxes and fees
Revocable living trust
Special needs trust