It is challenging to predict how much a person will have after death and how much they will be liable to federal estate taxes. The uncertainty of life itself is added to the mix—which spouse will outlast the other, will they remarry, and other significant life dilemmas.
It is critical to create an estate plan that promotes flexibility in the distribution of your estate property and maximizes the best tax benefits. Using a Qualified Terminable Interest Property Trust or QTIP trust is one of the more appealing choices that many married couples integrate into their estate plans.
Let’s get a better understanding of QTIP.
What Is a Qualified Terminable Interest Property (QTIP) Trust?
A QTIP trust is an irrevocable trust that allows the grantor to provide for a surviving spouse while maintaining control over how the trust’s assets are distributed after the surviving spouse’s death. The surviving spouse receives income and sometimes principal from the trust to ensure their financial security.
With a QTIP trust, the grantor can stipulate that after the surviving spouse dies, the assets in the trust will go to named beneficiaries such as children from a prior marriage. This type of trust is often used in second marriages in which each spouse wants to provide for the other and maintain control over how their respective children will inherit.
What Are the Advantages of Qualified Terminable Interest Property (QTIP) Trust?
QTIP trusts offer many advantages, including:
- Defer Estate Tax – The QTIP trust can help reduce estate taxes since estate taxes are delayed until the surviving spouse dies. However, it’s important to remember that the surviving spouse’s estate may incur taxes.
- Maximize Estate Tax Benefits – A QTIP trust allows you to maximize the federal estate tax marital deduction. The deduction allows unlimited assets to pass to a surviving spouse free of estate taxes.
- Flexibility – A QTIP trust provides flexibility in distributing your assets after your death. You can specify how the assets in the trust are to be used for your spouse’s benefit, and you can also name beneficiaries who will receive the assets after your spouse’s death.
- Control – With a QTIP trust, you maintain control over your assets after your death. This is because the trustee (the person who manages the trust) must follow your instructions as outlined in the trust document.
- Protection from creditors – All irrevocable trusts provide asset protection from creditors. There is less chance of losing assets in the case of lawsuits or debt collectors if a surviving spouse is solely allowed to receive income.
- Protection from a second spouse – A QTIP trust can benefit a blended family’s estate strategy. For example, if you remarry, you can set up a QTIP trust that pays out income to your spouse but ultimately gives the trust assets to your daughter from a previous marriage, the final beneficiary. This helps you to prepare for both people.
However, QTIP has also potential risks involved like:
- Trust is irrevocable – Once the trust is created, it cannot be changed. This means that you need to be sure of your estate planning goals before setting up a QTIP trust.
- Potential for Conflicts – Conflicts can arise if the trustee does not follow the grantor’s instructions or the beneficiaries do not agree to distribute the trust assets.
- Complicated tax rules – There are complex rules associated with QTIP trusts. For example, the value of the trust property must be included in the surviving spouse’s estate for estate tax purposes. As a result, it’s essential to work with an experienced estate planning attorney to ensure that the trust is properly structured and funded.
- Loss of Control – If you name your spouse as the trustee of the QTIP trust, they will have control over how the trust assets are invested and managed. This can be a good thing if you trust your spouse to make wise decisions. However, it can also be bad if you’re concerned about your spouse’s ability to handle money.
How Qualified Terminable Interest Property Trusts Work?
When you create a QTIP trust, you will name a trustee to manage the trust assets. The trustee will be responsible for investing the trust assets and distributing the income to the beneficiaries.
You will also name two types of beneficiaries in the trust document:
- The lifetime beneficiary – This person will receive the trust’s income during their lifetime.
- The remainder beneficiary – This is the person who will receive the trust assets after the death of the lifetime beneficiary.
The lifetime beneficiary must be your spouse. The remainder beneficiary can be anyone you choose, such as your children or other loved ones.
For example, let’s say you have a house worth $1 million and want to leave it to your children when you die. However, you are also concerned about your wife’s financial security after your death.
To achieve both goals, you could create a QTIP trust and name your wife as the lifetime beneficiary and your children as the remainder beneficiaries. Your wife would receive the income from the trust during her lifetime. Upon her death, the trust assets would be distributed to your children.
It’s important to note that the QTIP trust is irrevocable. Thus, it’s important to work with an experienced estate planning attorney to ensure that the trust is properly structured and funded.
When Should You Use a Qualified Terminable Interest Property (QTIP) Trust?
QTIP trusts can be created while you are still alive or through a will after you pass away. You can establish a trust that efficiently preserves your wealth, simplifies inheritance, and saves taxes with the guidance of the best legal minds.
A testamentary QTIP is the most common type of QTIP trust, which is established when the first spouse dies. This QTIP is essentially a marital trust created 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 established upon the first spouse’s death, or it may be part of a multi-trust arrangement in which the family trust receives the federal estate tax exemption.
QTIP trusts can also be established and paid while both spouses are still alive. These QTIP trusts are known as inter vivos (during lifetime) QTIP trusts. The grantor spouse contributes property to the QTIP trust for the other spouse’s benefit during the beneficiary’s lifetime. When the beneficiary spouse dies, the trust’s remainder will go to the grantor spouse’s children or wherever the grantor has specified. Suppose the grantor spouse is still alive upon the beneficiary spouse’s death. In that case, the grantor spouse can become the income and significant beneficiary, and the QTIP trust property is excluded from their inheritance.
What Makes a QTIP Trust Different From a Marital Trust?
QTIP Trusts operate similarly to Marital Trusts. They are both irrevocable trusts that can only name the surviving spouse as a beneficiary during the life of that spouse.
The main difference between the two is that with a QTIP Trust, the grantor retains control of the trust even after death. Marital trusts can also hold assets belonging to a deceased spouse, but they do not have some restrictions that QTIP trusts do. When a QTIP trust’s creator or grantor dies, their assets are transferred to the trust. The surviving spouse would then receive income from the trust assets.
Both types of trusts can assist with similar estate planning objectives. A QTIP gives the surviving spouse more control over trust funds, but a marital trust gives the surviving spouse more flexibility because it does not require annual distributions. Following the death of the original grantor, the surviving spouse of a marital trust can appoint new beneficiaries.
Who Pays Estate Tax in the Case of a Qualified Terminable Interest Property (QTIP) Trust?
The estate of the first spouse pays the estate tax to die. The QTIP trust will be included in their taxable estate. The taxes on the QTIP trust are paid from the trust’s assets, not from the assets of the second spouse.
For example, let’s say John and Jane have a QTIP trust with $1 million in assets. John dies, and the trust is included in his taxable estate. The estate tax on the $1 million QTIP trusts is $400,000. The taxes are paid from the trust assets, so the $1 million in assets is reduced to $600,000. Jane, the surviving spouse, is still the trust’s beneficiary and will receive all of the income from the trust for her lifetime. When Jane dies, the $600,000 in trust assets will be distributed to her beneficiaries following the terms of the trust.
Is a Qualified Terminable Interest Property (QTIP) Trust Revocable or Irrevocable?
A QTIP trust is an irrevocable trust. Once entrusted to a trustee, it cannot be easily changed or revoked. The trust terms and assets must be used as specified.