A QTIP trust (qualified terminable interest property) is an estate planning tool that can help married couples mitigate some of the uncertainty about how they will provide for each other while maximizing certain tax advantages.
A QTIP trust is a special trust that can be used to transfer assets in a trust to a spouse free of tax during their lifetime. This type of trust combines the protections of a trust with the marital deduction treatment that a transfer of property given to a spouse outright would receive.
A QTIP trust allows a grantor to:
- Maximize estate tax benefits by using the unlimited marital deduction.
- Allow the grantor spouse to put restrictions on how the beneficiary spouse can use the property in the trust. These restrictions are especially beneficial when the grantor spouse is concerned that a beneficiary spouse may remarry and give the trust property and assets to the new spouse.
Examples of how a QTIP trust may be used:
Suppose a young couple, Jeff and Mary, are married and have two young children. Mary has a very successful online business. Unfortunately, she was recently diagnosed with stage 4 breast cancer. She knows she is unlikely to outlive Jeff and that he will probably remarry.
Jeff and Mary establish a QTIP trust as part of their estate plan. Jeff will receive the benefits from Mary’s online business throughout his lifetime, but he cannot sell the trust’s property or give it to a new spouse. Mary knows that Jeff will be financially taken care of should she die first, but ultimately the trust property will pass to their children, not a second spouse.
Marty has recently married Rose. Rose has two adult children, and Marty has three. Marty, the wealthier of the two, wants to ensure Rose is financially taken care of for her lifetime, but he also wants to ensure that his three adult children receive the bulk of his estate. Marty transfers enough money and property to a QTIP trust to take care of Rose financially. He puts his remaining estate in a nonmarital trust for his children’s benefit. His adult children will also receive the remaining property in the QTIP trust, if any, after Rose dies. Marty’s adult children receive their inheritance during Rose’s lifetime, and Rose is financially provided for during her lifetime.
A testamentary QTIP is created when the first spouse dies. It is a trust that the couple establishes to hold money for the surviving spouse’s benefit. This may be the only trust created when the first spouse dies, or it may be part of a series of trusts. In a multiple trust arrangement, after the first spouse dies, the family or credit shelter trust may receive 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 federal marital trust in that the surviving spouse has restrictions and limits on their ability to use the property and money in the QTIP trust.
The appeal of these trusts for couples who have money and property valued at more than the lifetime estate tax exclusion amount is that it qualifies for the unlimited marital deduction, which delays the need to pay any required estate taxes until after the surviving spouse dies.
Inter Vivos Trust
An inter vivos (during lifetime) trust is created and funded when both spouses are still living. The grantor spouse, usually the wealthier of the pair, puts property into the trust for the benefit of the beneficiary spouse to be used during their lifetime. After the beneficiary spouse dies, the remaining property and accounts in the trust will go to the ultimate beneficiaries, typically the grantor’s children, but it could be anyone.
If the grantor spouse outlives the beneficiary spouse, the grantor spouse can become the beneficiary of the trust’s income and principal beneficiary, and the trust property will be excluded from their estate.
QTIP Trust Requirements
The QTIP trust must meet certain requirements:
- It must be an irrevocable trust.
- Only the beneficiary spouse can have the power of appointment for the trust property.
- The beneficiary spouse must have the right to demand that the trustee convert any non-income-producing assets into income-producing assets.
- Either all the trust’s net income must be paid annually to the beneficiary spouse, or they have the right to withdraw the trust’s net income annually. There cannot be any contingencies put on these rights, such as terminating this right upon remarriage.
- For an inter vivos QTIP trust, the beneficiary spouse must be a U.S. citizen.
The beneficiary spouse is the only person who can benefit from a QTIP trust throughout their lifetime. The beneficiary spouse may also be given the right to distributions from the trust principal, either at their discretion or after meeting certain standards, besides the income generated by the trust.
Who can be a trustee for the QTIP trust?
The grantor can name the spouse, an adult child, a trusted family member, or a third party as the trustee of the trust. QTIP trusts are frequently used when a spouse wants to financially care for a surviving spouse in a second marriage, while ensuring the principal of the trust property goes to their children from a first marriage. The surviving spouse may want the trust income to increase, while the children, as ultimate beneficiaries, may be more concerned about preserving the principal. In these cases, an outside party may be a better choice for the trustee.
QTIP trusts are a way for married couples to financially provide for the surviving spouse while maintaining control of how the trust property and assets are ultimately distributed while taking advantage of the unlimited marital deduction. Contact us to learn more about QTIP trusts.