Between the volatility of investment returns and changing federal tax laws, predicting how much a person will have at his or her death and how much will be subject to federal estate taxes is extremely difficult. Added to the mix is the uncertainty of life itself - which spouse will outlive the other, will he or she remarry, and other major life issues.
For these reasons, it is important to establish an estate plan that not only promotes flexibility in the allocation of your estate property, but that maximizes the best tax advantages as well. One of the more attractive options that many married couples incorporate into their estate plans is the use of a QTIP trust. It may sound like piece of cotton, but its true name is much more daunting - the Qualified Terminable Interest Property trust. The QTIP trust serves like a "crystal ball" for the uncertainty of the future. Not only does it provide for your surviving spouse and other loved ones after your death, but it also offers flexibility to your Executor in maximizing your federal estate tax savings.
How Does A QTIP Trust Work?
In its most basic form, a QTIP trust is essentially an A/B trust arrangement that is more restrictive than a typical marital trust. In most A/B trust arrangements, the marital, or A portion of the trust, is fully accessible by the surviving spouse. Conversely, a QTIP trust provides limited access to the trust assets for a surviving spouse. Although your spouse may receive income from the trust, he or she cannot decide on the ultimate disposition of the trust assets and cannot withdraw principal from the trust. However, the QTIP trust can be written to provide the greater of $5,000 or 5% of the trust assets to your surviving spouse annually if you wish. Upon the death of your surviving spouse, the trust is distributed according to your ultimate specifications.
A QTIP trust does not qualify for the estate tax marital deduction under traditional tax rules due to its restrictive nature. However, the tax code now permits your Executor to claim the marital deduction for amounts transferred to a QTIP trust by making an election on your death tax return.
Why Establish a QTIP Trust?
There are two main reasons why a married individual would choose to establish a QTIP trust. First, it may be unclear what your estate tax situation will be at the time the trust is put into effect. It may be prudent to provide flexibility for your Executor to elect between claiming a marital deduction for the amounts transferred to the QTIP or forego that deduction. This will allow your Executor to minimize the total estate tax paid by the two spouses combined by choosing to defer the tax on some, but not all, of the assets transferred in trust to a spouse. In other words, your Executor can choose the estate tax treatment of the QTIP trust to reflect changes in the applicable tax laws or changes in the value of your assets since you last made your will. It may also be beneficial if your surviving spouse already has significant personal assets. In that case, your Executor can take advantage of the graduated tax brackets in the estate tax law for both of you, in turn reducing the overall tax paid between both spouses.
The other, and perhaps more compelling reason, is that you may want to take advantage of the marital deduction for transfers made to your spouse in trust yet want to limit the power or ownership rights he or she has over the trust assets. The restrictive ownership provisions of a QTIP trust are particularly useful for second marriages since you may want to ensure that the amounts held in the trust will ultimately pass to your children or family and not the children or family of your second spouse.
Although complex in nature, a QTIP trust is considered an important component of any estate plan where flexibility regarding the timing of estate tax payments and the assurance that assets will ultimately pass to your family are your primary objectives.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.