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’s especially true for people who are in a second (or third) marriage, because a QTIP trust can prevent a second or third spouse from disinheriting children from a previous marriage.
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 creation of a QTIP trust, to be funded with the majority of his assets. His second wife, Flo, will be entitled to all of the income from the trust, for the remainder of her life. At Flo’s death, the remaining assets in the trust will go to Gregg Emerson and Helen Jenkins, Dwight’s children from a previous marriage.
Thus, Flo will be assured of cash flow for the rest of her life. However, she won’t be able to direct the QTIP trust assets to her own children, also from a prior marriage. Dwight can be certain that his children will receive the trust principal (i.e., the assets initially contributed to the trust at Dwight’s death) following Flo’s death.
This process can go both ways. Flo’s will could also call for the establishment of a QTIP trust for her assets, so that Dwight would receive lifetime income and her children would ultimately receive the trust assets.
What’s more, a QTIP trust can provide asset protection.
Example 2: Kirk and Lisa Miller are married with adult 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, including health care. Then, the remainder ultimately will go to their children.
With this arrangement, a remarriage after the death of the first spouse won’t lead to their children being disinherited. Control of the assets by a trustee will reduce the chance of depletion through squandering or imprudent investments by the surviving spouse.
Historically, QTIP trusts were used to defer estate tax until the death of the second spouse. With the federal estate tax exemption now at $5.43 million per person, scheduled to rise with inflation annually, federal estate tax is not an issue for many people.
Nevertheless, many states have their own estate tax or inheritance tax (Louisiana does not), with lower exemption levels. A couple with combined net worth of $3 or $4 million may wind up owing a substantial amount 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 carefully considered when determining whether to use this estate planning tool. In addition, couples with combined net worth in excess of $10 million may have federal estate tax exposure, so a QTIP trust could be worthwhile.
Just as well-drafted trusts may offer advantages, they 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 should also prepare your heirs for QTIP consequences. Your spouse, for example, should know that income will flow for the remainder of his/her life, but that access to trust principal will be limited. If your children will be the ultimate beneficiaries, they should understand they’ll have to wait for their inheritance, perhaps for many years. You may want to provide a more immediate source of funds to your children through life insurance 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.