How a Q-TIP Trust Protects Your Surviving Spouse,
and Other Members of Your Family
Married couples with modest wealth need to balance their taxable estates, so that both of their estate tax exclusion amounts will be used to offset estate tax liability. You might think that that each spouse must pass an equal value of assets to other members of the family upon death. But the Internal Revenue Code provides another way to use both exclusions, and provide for the surviving spouse: the QTIP trust.
Consider a QTIP trust, instead of making an outright gift of assets during your lifetime, or passing control and ownership to other family members upon death of the first spouse. The QTIP will save the state and federal estate tax exclusion amounts for both spouses, and protect family harmony. The two top reasons, after estate tax savings, that people use a QTIP are:
1. Concern about the surviving spouse's ability to manage the assets in future years. The surviving spouse might become vulnerable to bad financial advice or scammers, or be subjected to influence by other family members who have their own interests in mind. The QTIP trust insulates the spouse and the inheritance from these bad actors. The QTIP provides instructions and guidance and even a professional trustee to help the spouse protect the trust principal, and her stream of income from the trust.
2. Possibility that the surviving spouse might change the plans for who gets the remaining assets. This is related to the concern about undue influence of other family members. The Q-TIP trust is a valuable tool when one spouse does not want the surviving spouse to be subject to the temptation or pressure to change the ultimate disposition of the couple's assets. With a QTIP, the trust ensures that the assets will pass to whoever you designate in the document to receive the remaining assets. Additional instructions can also distribute the remaining assets in stages, or at certain ages, to surviving family members.
QTIP Example: Second Marriage Scenario of Mr. and Mrs. Quiniones
A dramatic example that illustrates the importance of using a QTIP is the second marriage situation where Mr. Quinones has two children from a previous marriage.
After the death of his first wife, he married Jennifer, and set up a QTIP Trust for her. (He could also arrange for the QTIP as part of his Will.) When Mr. Q dies, Jennifer Q. will get a lifetime interest in the income from the QTIP trust.
If Mr Q names the children of his first marriage as the remainder beneficiaries, they will get the remainder of the property upon Jennifer's death. Jennifer has no power to change the beneficiaries named in the QTIP. Mr. Q can rest peacefully, knowing that his children from his first marriage will receive the assets remaining in the trust after the death of Jennifer. QTIP stands for Qualified Terminable Interest Property.
How it Works
The QTIP Trust holds property, and entitles the surviving spouse to all the income from the property for her lifetime (payable annually or at more frequent intervals) or gives her the right to use the property for her lifetime. No one can allocate any part of the property to anyone except Mrs. Q, the surviving spouse.
The QTIP trust allows Mr. Q to save estate taxes and cover the other two estate planning concerns:
1. provide income for spouse Jennifer. The Trust will provide for his surviving spouse.
2. make sure that all of their remaining assets pass to the children of his first marriage. If Jennifer remarries after Mr. Q's death, the QTIP assets do not become part of the marital assets of her subsequent marriage. The Trust keeps control over who receives the property that is left in the trust after the death of the surviving spouse.
Source of Funds, and The Funding Amount, are Up To You
How much of Mr. Q's estate would go into the QTIP trust? As much as he chooses. Mr. Q may even decide to direct retirement plan assets to the QTIP. IRS Revenue Ruling 2000-2 says an executor may elect under § 2056(b)(7) to treat an IRA and a trust as QTIP when the trustee of the trust is the named beneficiary of the decedent's IRA. The surviving spouse can compel the trustee to withdraw from the IRA an amount equal to all the income earned on the IRA assets at least annually and to distribute that amount to the spouse, and no person has a power to appoint any part of the trust property to any person other than the spouse.
Estate Tax and Income Tax Issues
No estate taxes would be generated by Mr. Q's QTIP bequest to Jennifer, because of the 100% marital deduction . But the full value of the remainder interest at the time of Jennifer's death must be included in her estate. If the QTIP assets appreciate in value during Jennifer's lifetime, this could lead to estate taxes upon her death, if her estate is over the exclusion amount. Mr. Q's children might have preferred to simply pay any estate taxes at Mr. Q's death, and take their inheritance immediately. But they will know that Mr. Q made the choice to take care of Jennifer during her lifetime.