Key takeaways about trusts for children

  • Testamentary trusts are created in the will and can make sure minors don't receive all their inheritance at once. They are probate assets and can be vulnerable to creditors

  • Minor's trusts are irrevocable living trusts that generally protect assets from debts.

  • Many minor's trusts are set up in different ways to take advantage of the gift tax exclusion.

  • Income from these trusts is still taxed as income, and can have an effect on the minor's finances.

While it’s not a pleasant thing for anyone to think about, many parents, mindful of the possibility that they might pass away before their children turn 18, take steps to ensure their family will be cared for financially in their absence. 

While some make these provisions in a will, other parents create trusts. Trusts are legal agreements that offer clear instructions on when and how assets should be doled out by a designated trustee to a young beneficiary. With trusts, children typically receive incremental support, rather than a single disbursement as in a will. Most children lack the maturity to make important financial decisions, and this helps preserve their interests until they come of age.

Although many people think only the super-wealthy benefit from trusts, the fact is that savvy families across the financial spectrum take advantage of this estate planning tool. For one thing, some trusts do not have to undergo review by the probate court; their terms are therefore private and excluded from the public record, making contesting them extremely difficult. Probate exclusion also means that distribution of their assets can kick in right after a loved one passes away. By contrast, bequests in a will are only delivered after all debts, creditors, and taxes are paid out of the estate, a process that in some cases can take months if not years.

Determining whether a trust is right for your family is complicated. If you are thinking about establishing a trust for your minor children, consider consulting with an attorney who can help you navigate the ins and outs of this course of action. 

Testamentary trusts

When you establish a testamentary trust for a child, you are choosing to leave assets to your child via the care of a trustee should you pass away. Testamentary trusts are created by the terms of your will, and are therefore not able to be changed once established, as the trust does not exist while you are living.

Because they are part of the will, minor’s trusts are probated assets. They are part of the estate of the person who passed away and can be claimed by their creditors, though the trust does provide a bit more protection to these assets than the other assets in the estate.

Minor’s trusts

In order for the assets in a trust to be fully protected from creditors, it needs to be specifically created during a person’s lifetime and crafted so that the assets are no longer under their control or ownership, a kind of trust generally known as an irrevocable living trust.

When the person passes away, these assets remain in the trust, are not included in their probated estate, and are therefore generally not subject to the person’s debts. If the funds in the trust are designated to be distributed to minor children at some later date, this is a kind of irrevocable trust known as a minor’s trust, which can be set up in several different ways.

2053(c) trust

Among popular minor’s trusts are 2053(c) trusts, which allow gift tax exemptions for gifts made into the trust. Normally, gifts are excluded from counting toward your lifetime gift-giving tax limit as long as they are under a certain annual threshold (currently $15,000). But this exclusion only works if you give a gift to a recipient in the “present interest,” that is for use right now, not in expectation that they will get the money in the future, as is generally the case with a trust. 

It is important to make sure that you do not name yourself as a trustee when you create a minor’s trust.

With a 2053(c) trust, a parent, grandparent or other donor can make a gift to the trust without having it count toward their gift tax limit, provided that the child is the only beneficiary of the trust; that any income the trust generates as well as its original assets go to your child at 21; and that if your child should themselves pass away before reaching 21, the assets in their trust will go to the estate.

2053(b) trust

Similarly, in a 2053(b) trust, income generated from the trust must be distributed each year. This is how this trust meets the “present interest” criterion in order to help donors take advantage of the gift tax exclusion, while the trust’s principal can stay put in the trust even after the child turns 21. 

This may also have other tax advantages, as the trust income is counted as the child’s and taxed under their personal income tax, rather than income for the trust, which can often be taxed at a much higher rate.

Crummey trust

Named for a 1968 court case, Crummey trusts are, like 2503(c) and 2503(b) trusts, irrevocable and established in part to help minor children while taking advantage of gift tax exclusions. 

Crummey trusts can have multiple beneficiaries and have no requirement that their assets be distributed to a beneficiary when they turn 21. Assets in a Crummey trust can stay there for many years into the beneficiary’s adulthood.

A Crummey beneficiary or their trustee has the right to withdraw assets within a limited time period after a contribution to the trust has been made. This right makes the trust a gift with “present interest,” thus exempting it from gift tax, even when that right is exercised. 

Taxing trusts

Do not assume, however, that avoiding the gift tax means avoiding all taxes. Trusts pay both federal and state taxes on undistributed earnings, and tend to be taxed in the highest possible tax bracket. If a trust generates a lot of income, therefore, it may wind up paying a lot of taxes. 

In addition, in some cases a child may be taxed on trust income they receive even while minors, and the trust’s assets may be considered as a factor in determining your child’s eligibility for financial aid.

It is important to make sure that you do not name yourself as a trustee when you create a minor’s trust, as the trust will then be considered part of your estate should you pass away before your child reaches 21. 

For many people, trusts hold great appeal. That said, they cost a lot more than wills to set up—and there are many different kinds of trusts beyond the three mentioned here. 

Given that gift tax exclusions and tax rates change as frequently as once a year, it is imperative to understand how to best try to minimize tax liability for you and your children. This can take a lot of time; consult with a financial advisor and an estate lawyer to be sure a trust is right for you and that you are creating it as efficiently and frugally as possible ●