What Is a Qualified Terminable Interest Property (QTIP) Trust?

A qualified terminable interest property (QTIP) enables the grantor to provide for a surviving spouse and maintain control of how the trust's assets are distributed once the surviving spouse dies. Income, and sometimes principal, generated from the trust is given to the surviving spouse to ensure that the spouse is taken care of for the rest of their life.

• A QTIP trust serves like a “crystal ball” for the uncertainty of the future for married couples.
• A QTIP trust is a marital trust designed to provide for your spouse after your death while protecting your assets for future generations.
• The QTIP trust also offers flexibility to your Executor in maximizing your federal estate tax savings.
• A qualified terminable interest property (QTIP) trust allows an individual, called the grantor, to leave assets for a surviving spouse and also determine how the trust's assets are split up after the surviving spouse dies.
• Under a QTIP, income is paid to a surviving spouse, while the balance of the funds is held in trust until that spouse's death, at which point it is then paid out to the beneficiaries specified by the grantor.
• QTIP trusts are put to use in estate planning and are especially useful when beneficiaries exist from a previous marriage but the grantor dies before a subsequent spouse does.
• With a QTIP, estate tax is not assessed at the point of the first spouse's death, but is instead determined after the second spouse has passed.

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’s 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 in marital trust planning. 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.

This type of irrevocable trust is commonly used by individuals who have children from another marriage. QTIPs enable the grantor to look after his current spouse and make sure that the assets from the trust are then passed on to beneficiaries of his choice, such as the children from the grantor's first marriage.

Aside from providing the living spouse with a source of funds, a QTIP can also help limit applicable death and gift taxes. Additionally, it can assert control over how the funds are handled should the surviving spouse die, as the spouse never assumes the power of appointment over the principal. This can prevent these assets from transferring to the living spouse’s new spouse, should she remarry.

The property within the QTIP providing funds to a surviving spouse qualifies for marital deductions, meaning the value of the trust is not taxable after the first spouse’s death. Instead, the property becomes taxable after the second spouse's death, with liability transferring to the named beneficiaries of the assets within the trust.

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 estate 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.

Qualified Terminable Interest Property Trustee Appointments

A minimum of one trustee must be appointed to manage the trust, though multiple individuals or organizations may be named simultaneously. The trustee or trustees will be responsible for controlling the trust and will also have authority over how its assets are managed. Examples of possible trustees include, but are not limited to, the surviving spouse, a financial institution, an attorney and other family members or friends.

In a marital gift trust, the estate is split in two, with one section put in a trust fund and the second given directly to the surviving spouse; just like with a QTIP, there is no estate tax charged against either share, but unlike with a QTIP, the surviving spouse can typically appoint beneficiaries of the trust following their death.

The surviving spouse named within a QTIP receives payments from the trust based on the income the trust generates, similar to the issuance of stock dividends. As the surviving spouse is never the true owner of the property, a lien cannot be put against the property within the trust or the trust itself. Payments will be made to the spouse for the rest of their life. Upon death, the payments cease, as they are not transferable to another person. The assets in the trust then become the property of the listed beneficiaries.