What is a QTIP Trust?
Perhaps the most uniquely named estate planning tool is the Qualified Terminable Interest Property Trust, also known as a QTIP trust. What is a QTIP trust? Here’s how this estate planning tool can provide for a surviving spouse while preserving an inheritance for your children from a prior marriage.
What Is a Qualified Terminable Interest Property (QTIP) Trust?
A Qualified Terminable Interest Property (or QTIP) trust is a type of irrevocable trust often used by individuals who have children from a prior marriage. A QTIP trust helps the trust grantor care for their spouse while also ensuring that after the surviving spouse dies, the trust assets pass to beneficiaries of their choice. Often these beneficiaries include children from the grantor’s first marriage, but may also include other relatives or friends.
A QTIP trust can also help limit estate and gift taxes for individuals with large estates. The property within the QTIP trust that provides income to a surviving spouse qualifies for marital deductions. This means that the assets in the trust will not be taxed at the first spouse’s death, but after the death of the second spouse. The named trust beneficiaries will be responsible for paying taxes at that time.
Why Create a QTIP Trust?
QTIP trusts are popular amongst blended families because they provide for the surviving spouse while ensuring that whatever is left after the second spouse’s passing is distributed to the grantor’s chosen beneficiaries.
With a QTIP, the surviving spouse never assumes the “power of appointment” over the principal. That means they can’t leave those assets to their children or family. If your spouse remarried after your death, these assets will also not transfer to their new spouse. This preserves an inheritance for your intended beneficiaries.
How Does a QTIP Trust Work?
Here are the basic mechanics of a QTIP trust: The trust must give a minimum of an income interest for life to the surviving spouse. If desired, the trust can be drafted to also provide annual principal distributions for basic needs (such as health, education, maintenance, and support). However, principal distributions are not required.
When one spouse dies, the trust assets transfer into a QTIP trust, and no estate taxes are paid. The trust pays an annual income to the surviving spouse. At the death of the second spouse, the trust property is includable in their gross estate for estate tax purposes. All trust assets are distributed to the named trust beneficiaries.
Here’s an example of how this kind of trust might work: Husband Sam has three children from a previous marriage and is remarried to Sally. He works with his estate planning attorney to establish a QTIP trust. After 10 years of marriage, Sam dies. The trust names Sally and Sam’s oldest daughter Sarah as co-trustees. The trust gives all the trust income earned to his wife Sally and also allows for principal distributions for her health, education, maintenance, or support.
After Sally dies, whatever assets remain in the trust will be distributed to Sam’s three children. By structuring his estate plan this way, he provides support for his wife as long as she’s alive, but ensures that anything leftover after her death goes to his own three children- and not Sally’s two children from her previous marriage.
QTIP vs. Marital (A/B) Trust
A QTIP trust is similar in several ways to a marital (or A/B) trust. An A/B trust is another popular estate planning tool for wealthy couples to reduce federal estate taxes. Here are the similarities between these two types of trusts:
- Both are irrevocable trusts that only name the spouse as the beneficiary.
- Both receive an unlimited marital deduction.
- Both defer taxes until the second spouse’s death.
But a QTIP trust has more restrictions than a marital trust. A marital trust gives the surviving spouse control over the trust principal and income and lets them decide how the trust assets will be distributed. It doesn’t require the surviving spouse to take annual distributions. The surviving spouse can even add new beneficiaries after the death of the original grantor.
If you want to make sure that your portion of the estate goes to a specific beneficiary, like your children from a previous marriage, a QTIP trust may be a good option. If you’re only focused on minimizing estate taxes, a marital trust may suffice instead.
Always consult with an experienced estate planning attorney about which type of trust will best serve your needs. If you have any questions about this topic, feel free to contact our law firm.
Law Offices of Daniel A. Hunt
The Law Offices of Daniel A. Hunt is a California law firm specializing in Estate Planning; Trust Administration & Litigation; Probate; and Conservatorships. We've helped over 10,000 clients find peace of mind. We serve clients throughout the greater Sacramento region and the state of California.