Will My Spouse Get What They Need?

What is a QTIP trust?

A qualified terminable interest property (QTIP) trust is an estate planning tool that married couples can use to minimize uncertainty about the future and maximize certain tax advantages. Since no one can predict how much they will own at the time of their death, which spouse will die first, whether the surviving spouse will remarry, or what the estate tax rate will be when they die, a QTIP trust can help deal with and minimize these uncertainties without the need for a crystal ball.

The most common form of QTIP trust is a testamentary QTIP, which is created when the first spouse dies. Basically, this QTIP is a marital trust established as part of a married couple’s estate plan to hold money and property for the surviving spouse’s benefit. This trust may be the only one created at the first spouse’s death, or it may be part of a multiple trust arrangement where, after the first spouse’s death, the family trust (or credit shelter trust) receives an amount equal to the federal estate tax exemption and the marital trust receives the rest. A QTIP trust is more restrictive than a typical marital trust in that the QTIP trust limits the surviving spouse’s ability to use or control the marital trust’s assets, such as money and property. However, for couples who have or may have accounts and property valued at more than the lifetime estate tax exclusion amount, a QTIP trust is especially appealing because it qualifies for the unlimited marital deduction, which delays the payment of estate tax, if any, until the surviving spouse dies.

However, QTIP trusts can also be created and funded while both spouses are living. These types of QTIP trusts are called inter vivos (during lifetime) QTIP trusts. The grantor spouse (usually the wealthier spouse) puts property into the QTIP trust for the benefit of the other spouse (the “beneficiary”) during the beneficiary spouse’s lifetime. At the beneficiary spouse’s death, the trust’s remainder will go to the grantor spouse’s children or wherever the grantor has decided. If the grantor spouse is still living at the beneficiary spouse’s death, the grantor spouse can even become the income and principal beneficiary and the QTIP trust property will be excluded from their estate.

Whether they are created after death or during life, QTIP trusts must meet certain requirements:

• The QTIP trust must grant the beneficiary spouse a “qualifying income interest for life.” Either all the trust’s net income must be paid at least annually to the beneficiary spouse, or the beneficiary spouse must have the right to annually withdraw all the trust’s net income. This right to income cannot be subject to any contingencies. For example, the right to income cannot terminate upon the surviving spouse’s remarriage.
• Only the beneficiary spouse can have the power to appoint the trust property.
• The beneficiary spouse must have the right to demand that the trustee convert non–income producing assets into income-producing assets.
• The QTIP must be irrevocable.
• For an inter vivos QTIP trust, the beneficiary spouse must be a US citizen.

It is permissible, though not required, to also give a beneficiary spouse the right to distributions from the trust principal (either discretionary or according to certain standards). However, no person other than the spouse can be a beneficiary of the QTIP trust during the beneficiary spouse’s lifetime.

Who can be the trustee of a QTIP trust?

The trustee of a QTIP trust is responsible for managing the trust’s accounts and property, filing the trust’s tax returns, and other administrative tasks required in following the terms of the trust. Because being a trustee can be a heavy responsibility, some people choose a third party, such as a financial institution or an attorney, to fill the role.

A grantor can, however, name a trusted family member, including the beneficiary spouse, as trustee of a QTIP trust. A grantor considering this option should keep in mind that such an arrangement may introduce distrust or even discord into relationships. For example, the surviving spouse of a second marriage, acting as trustee, may choose to invest in accounts or property that will provide a larger amount of trust income, but the children of the grantor’s first marriage (who are the ultimate QTIP trust beneficiaries) may prefer that the surviving spouse trustee invest in accounts or property that will preserve or grow trust principal. Such competing interests may cause conflict between the parties.

Why would someone use a QTIP trust?

Qualified terminable interest property trusts serve two main purposes: (1) they can allow the maximization of estate tax benefits by using the unlimited marital deduction, and (2) they allow a grantor spouse to put restrictions on their property rather than leave the property outright to their spouse. These restrictions are useful in second marriages when there are children from the first marriage or when there are concerns about a spouse remarrying and giving away all the couple’s money and property to a new spouse.

Example 1: Alice and Ben are in their midthirties, have been married for ten years, and have two young children. Alice has a successful internet business selling doll clothes. Alice has faced some health challenges and realizes that she will probably not outlive Ben and that Ben, as a young widower, will most likely remarry. When creating their estate plan, Alice and Ben include provisions for a QTIP trust that, if Alice dies first, will allow Ben to receive the income from Alice’s internet business (and the other QTIP trust accounts and property) for his lifetime but does not allow him to sell the trust’s property or give them away to a new spouse. Alice has the peace of mind of knowing that her business and the other trust accounts and property will eventually pass to her children after Ben’s death.

Example 2: John is a successful businessperson in his late sixties who has three adult children from his first marriage. John has recently married Karen, his former high school sweetheart, who had never married. John wants to ensure that Karen is provided for both during life and after his death, but he also wants to ensure that his children receive the bulk of his money and property. John transfers a portion of his money and property to a QTIP trust for Karen’s benefit and the remaining amount to a nonmarital trust for his children’s benefit. The income generated by the QTIP trust’s accounts and property will provide for Karen during her life, and John’s children will receive the remaining property, if any, in the QTIP trust after Karen’s death. John’s children do not have to wait for Karen to pass away before receiving an inheritance because they can benefit immediately from the accounts and property in the nonmarital trust.

For married couples, providing for the surviving spouse is usually a top priority. However, couples may also have additional priorities that they want to honor with their estate plan. A QTIP trust can offer an effective solution by allowing you to provide for your surviving spouse, maintain control over the ultimate transfer of assets, and take advantage of the unlimited marital deduction. To learn more about how a QTIP trust could help your estate planning goals, give us a call.