A QTIP trust is one of the best-kept secrets in estate planning. A QTIP is officially known as a Qualified Terminable Interest Property trust. It is a type of trust that allows people to provide income to their surviving spouse and then leave the property and assets to different beneficiaries.
The QTIP will also reduce the decedent’s estate because the trust assets that the surviving spouse inherits are typically not taxed thanks to the marital deduction. Instead, the estate tax gets deferred until the surviving spouse passes away when the trust assets are included in their taxable estate.
However, the good news is that only estates that exceed the estate tax exemption limit the pay estate tax.
A QTIP is like a marital trust, which also holds the spouse’s assets who passes away first. However, the QTIP trust has more restrictions. When one spouse dies, the trust assets transfer into a QTIP trust, and no estate taxes are paid at this time.
The QTIP will pay the income to the surviving spouse, who may also use some of the trust assets for their benefit, but the trust assets are inherited by someone else of your choosing, like your child from a previous marriage. But when the surviving spouse passes away, the QTIP assets are includable in their gross estate.
Table of contents
What is a QTIP Trust and when should it be used?
The QTIP is usually created while you are living. Alternatively, you can have the assets transferred upon your death. This is usually done via will. But a QTIP can also be created after a spouse passes away. The rules for setting up a QTIP trust established during a grantor’s lifetime may be slightly different, so consult with an estate planning attorney for more detail.
When a QTIP trust is established, a trustee will be named, and two types of beneficiaries will be established. One is a lifetime beneficiary, and the other is a remainder beneficiary (sometimes referred to as a final beneficiary).
The surviving spouse is typically the lifetime beneficiary who will receive the income from the trust over their life. The spouse will also have restricted access to some of the trust assets.
The remainder beneficiary is the person or entity that receives trust assets when the surviving spouse passes away. The QTIP is an irrevocable trust, so the grantor is unable to modify it.
Let’s look at a typical example. Let’s assume you contribute mutual funds and a rental property into a QTIP and then name your spouse as the lifetime beneficiary and your son as the remainder beneficiary. This is a very typical situation.
When you pass away, your spouse will receive the income generated from the QTIP trust. But remember, they cannot sell or dispose of the assets because they do not own the assets.
QTIP Trust Requirements
An excellent feature of the QTIP is that the surviving spouse receives the trust income for the rest of their life, no questions asked. The trust income that is distributed to the spouse can be fixed or a specified amount. The spouse will have limited access to the trust’s principal. Still, they may receive some of it in certain circumstances, such as education, health, support, and maintenance.
While a trust can hold many different asset classes, the QTIP must contain some income-producing property. This could be rental real estate or stocks, bonds, or mutual funds.
The primary goal is to provide an income stream for the surviving spouse, so a QTIP trust is not a good option if the assets aren’t income-producing. When the trust is established, the grantor can specify that any non-income-producing assets are sold or disposed of to generate income.
QTIP Principal Distributions
When a QTIP trust is structured correctly, the assets will qualify for the marital deduction. The marital deduction allows the assets to pass to a surviving spouse tax-free.
For the marital deduction to work, one spouse generally must pass the assets directly to the surviving spouse. However, with a QTIP trust, the surviving spouse can access the trust income but not direct ownership of the assets.
The QTIP trust is structured to distribute the income, and the surviving spouse merely has a “qualified lifetime interest.” The marital deduction will ensure that the QTIP assets do not count as part of the decedent’s estate.
Suppose you choose for property to transfer to a QTIP trust upon your death. In that case, the executor would claim the marital deduction on the federal estate tax return by listing the related property on Schedule M to the estate tax return.
The QTIP trust will ultimately terminate when the surviving spouse passes away. At this point, the assets will be distributed to the final beneficiaries. The assets are included as part of the surviving spouse’s estate, and estate tax must be paid if combined assets are over the exemption limit.
QTIP trust vs Marital Trust
QTIP trusts are very similar to marital trusts. Some consider the QTIP to be a specific type of marital trust. These trusts can be typically be customized to meet the estate needs.
A marital trust is generally just a trust created when the first spouse passes away. The surviving spouse then has access to the assets in some capacity. It is similar to a bypass trust, which is also called an “AB” trust.
But unlike a QTIP trust, the surviving spouse will typically have complete control over assets in a marital trust. This includes access to trust assets and the ability to designate final beneficiaries.
A QTIP will generally offer more control to the grantor, but less control to the surviving spouse compared to a marital trust. The surviving spouse does not have final say in the beneficiaries and has minimal control over the assets. The spouse merely receives only the trust income. The marital trust has more flexibility and can be modified or customized to fit the situation.
Why choose a QTIP trust?
A QTIP won’t work for everybody. It is more complex to establish compared to a revocable trust and will require annual tax filings. A marital or bypass trust may work just fine. How considerable your wealth is and your desire to keep marital assets separate will dictate the extent to which you need this specific type of trust.
Estate tax deferral
The QTIP will help reduce estate taxes because any potential estate taxes are deferred until the surviving spouse’s death. The surviving spouse may have to pay estate tax once they pass away, depending on the size of the estate and the estate tax exemption on the date of death.
The truth is that most people don’t have assets that exceed the estate tax exemption. But if desired, a credit shelter trust can be established in addition to the QTIP trust.
Protection from family members or a second spouse
A QTIP can work great when there is a blended family. For example, if a surviving spouse gets remarried, the assets will not ultimately go to the surviving spouse and the new spouse.
You can set up a QTIP trust that distributes the income to the spouse, but the assets can ultimately go to a child from a prior marriage. The child would be the final beneficiary. This allows planning when multiple spouses and children are involved.
The QTIP can be established with your child as the final beneficiary while your spouse would receive the income distribution. If the surviving spouse remarries and has a child with a new partner, they cannot redirect the QTIP trust assets to their new child.
QTIP Trust Sample & Example
The good news is that all irrevocable trusts will offer some form of credit or asset protection. Since the surviving spouse has the right to receive income, the chance of exposing the assets to legal issues is lower.
The assets also do not count toward Medicare limits. The QTIP will help any surviving spouse qualify for long-term care as long as their income is below the Medicare eligibility requirements.
Revocable or Irrevocable?
Individuals who become incapacitated and haven’t planned can have a guardian appointed by the court. The guardian would have legal authority over the finances, including funds in a revocable living trust. Still, they won’t be able to touch assets in an irrevocable trust such as a QTIP.
