QTIP Trusts Still Offer Advantages

Case Study

09 Dec QTIP Trusts Still Offer Advantages

For many people, trusts can play a role in estate planning. Indeed, a qualified terminable interest property (QTIP) trust may offer benefits to married couples. That is especially true for people who are in a second (or even a third) marriage because a QTIP trust can prevent a second spouse from disinheriting children from a first marriage.

Extending control

A QTIP trust allows the creator (grantor) to provide funds for a surviving spouse and also name the final beneficiaries.

Example 1: Dwight Emerson’s will calls for the establishment of a QTIP trust to be funded with most of his assets. His second wife, Flo, will be entitled to all of the income from the QTIP trust, for as long as she lives. At Flo’s death, the assets remaining in the trust will go to Gregg Emerson and Helen Jenkins, Dwight’s children from a prior marriage.

Thus, Flo will be assured of cash flow for the rest of her life. However, she will not be able to direct the QTIP trust assets to her own children, also from a prior marriage. Dwight can be sure that his children will receive whatever is left in the trust after Flo’s death.

This process can go both ways. Flo’s will also can create a QTIP trust for her assets, so that Dwight would receive lifetime income if he is the surviving spouse, yet Flo’s children would ultimately get the trust assets.

Asset protection

A QTIP trust also can provide asset protection.

Example 2: Kirk and Laurie Miller are married with grown children. Both Millers have wills calling for all of their assets to go into QTIP trusts. The surviving spouse will get all the trust income. In addition, the local bank named as trustee will be instructed to provide the survivor with additional funds from the trust, if necessary for ordinary living expenses, such as health care. Then, the remainder ultimately will go to their children.

With this arrangement, a remarriage after the death of the first spouse will not lead to their children being disinherited. Asset control by a trustee will reduce the chance of depletion through squandering or unwise investments by the surviving spouse.

Tax benefits

Historically, QTIP trusts were used to defer estate tax to the death of the second spouse. With the federal estate tax exemption now at $5.43 million per person, scheduled to rise with inflation, federal estate tax is not a concern for many people.

Nevertheless, many states have their own estate tax or inheritance tax, with lower exemption levels. A couple with combined net worth of $3 million or $4 million might wind up owing substantial amounts of state tax at death, so tax deferral through a QTIP trust could be valuable. State rules regarding QTIP trusts vary greatly, however, so the applicable state’s rules must be reviewed carefully when determining whether to use a QTIP trust. In addition, couples with combined net worth well in excess of $10 million may have federal estate tax exposure, so a QTIP trust could be worthwhile for them.

Addressing concerns

Just as any well-drafted trust may offer advantages, trusts also require time and expense to create and maintain. Moreover, a QTIP trust poses specific issues in addition to the usual cautions about using a knowledgeable attorney to set it up.

With a QTIP trust, the executor will have to make a required election after the grantor’s death. A separate state election also may be required to get QTIP tax treatment. Thus, if you create a QTIP trust, the trustee you name should be prepared to make a well-considered election.

You also should prepare your heirs for QTIP consequences. Your spouse, for example, should know that income will flow life-long, but access to the trust principal will be limited. If your children will be the ultimate beneficiaries, they should understand they will have to wait for their inheritance, perhaps for many years. You might want to provide a more immediate source of funds to your children through insurance on your life or through a bequest outside of the trust.

In addition, you should discuss ongoing investment of trust assets with your chosen trustee. A QTIP trust must be invested to generate income to the surviving spouse, yet the trustee should attempt to provide a substantial amount to the ultimate beneficiaries as well.

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