QTIP Trusts

These trusts are especially useful in second marriages.

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This oddly named trust is used by many wealthy couples. It serves two main purposes:

  • It lets you put strings on your property, rather than leaving it to your spouse outright—useful if you’re in a second marriage and want to provide for both your current spouse and your children from a previous marriage.
  • When one spouse dies, it lets the survivor decide how much (if any) of the deceased spouse’s property should be held in trust to maximize estate tax savings--useful in these times of continual change and uncertainty about the estate tax.

QTIP, by the way, is an abbreviation for “Qualified Terminable Interest Property.” You can see why people prefer the catchy acronym to the full name.

How a QTIP Trust Works to Control Property

Each spouse can set up a QTIP trust, leaving assets to the other in trust. When the first spouse dies, the survivor gets what’s called a “life estate” in the assets that are left to the QTIP trust—that is, the survivor is entitled to any income the assets produce, and in the case of real estate, to its use. Only the surviving spouse can be named as the life beneficiary. The survivor does not, however, have full ownership of the trust assets and cannot sell them or give them away.

When the second spouse dies, trust assets go to the “final beneficiary” named in the trust. Commonly, the final beneficiaries are children from the other spouse’s previous marriage.

Example: Jim sets up a QTIP trust, naming his wife Janice as the life beneficiary and his sons from a previous marriage as the final beneficiaries. Jim dies first, leaving Janice a life estate in the assets that are left to the QTIP trust, their house and some investment accounts. She is paid the income the accounts produce, and has the right to live in the house. She can’t sell the trust assets, give them away, or leave them at her death. At her death, the assets will pass to Jim’s sons.

When you set up a QTIP, you must name a trustee as well as beneficiaries. You can name your spouse to be the trustee, choose one of your adult children, or pick a disinterested third party. Professionals will serve as trustees for a fee (usually a percentage of the value of trust assets), but only if the value of the trust assets is large enough.

Making it clear that your children from a previous marriage will ultimately inherit assets can be a good way to reduce family tension. When you spell out the arrangements in a solid estate plan, your children can relax. They don’t have to be afraid that their stepparent will squander the family inheritance, leave it all to his or her own relatives, or remarry and leave it to a new spouse. By contrast, simply leaving all your assets to your spouse, trusting him or her to provide for your children from a previous marriage, can be asking for trouble. Your children may worry—with or without justification—that they’ll be left out in the cold. (See “Estate Planning and Your Blended Family.”)

Of course, no piece of paper can ever eliminate all traces of family discord. Children may keep a suspicious eye on a stepparent’s management of QTIP assets, wishing that investment strategy would be focus on producing income (which goes to the surviving spouse) and not on growth (which will eventually benefit them). You and your spouse are the only ones who can decide whether a QTIP trust arrangement would be likely to improve or hurt relations between your spouse and your children.

How a QTIP Trust Works to Defer Estate Tax

A QTIP trust doesn’t eliminate estate tax; it postpones it until the death of the second spouse. If you create a QTIP trust, then at your death no estate tax is due on the assets that go into the trust. The assets qualify for the unlimited marital deduction, which lets all property, regardless of value, pass to a surviving spouse free of estate tax.

You can get the estate tax benefits of a QTIP trust only if your spouse is a U.S. citizen. The marital deduction (the rule that lets surviving spouses inherit any amount from the deceased spouse free of estate tax) is key to the QTIP, and it doesn’t apply to noncitizens. You may want to consider another kind of trust, the QDOT or Qualified Domestic Trust, which may help you accomplish your tax-related goals.

Legally married same-sex couples could not, at one time, take advantage of QTIP trusts. But since June 2013, when the U.S. Supreme Court found parts of the federal Defense of Marriage Act (DOMA) unconstitutional, the IRS has recognized the legal marriages of same-sex couples, regardless of what state the couples live in. These couples may claim all benefits granted to married couples under the tax law, including the marital deduction.

At the death of the second spouse, estate tax is due on all of that spouse’s property, including the assets that were held in the QTIP trust. For deaths in 2015, federal estate tax will be owed only if the assets exceed $5.43 million in value. (The figure for 2014 deaths was $5.34 million.) More than 99.5% of all estates are not that valuable and do don't owe any estate federal tax.

Learn more about federal estate and gift tax.

The QTIP Election

Another advantage of a QTIP trust is that is provides some flexibility for the surviving spouse. If by the time of the first spouse’s death, your family’s financial situation—or estate tax laws—have changed since the trust was drawn up, the survivor doesn’t have to implement it.  The decision is officially in the hands of the person you name as the executor of your will, who may or may not be your spouse. To create the QTIP trust, the executor must make a “QTIP election” on the estate tax return that’s filed for the estate of the first spouse to die.

To make the election, the executor lists, on a schedule attached to the estate tax return, the assets that are to go into the QTIP trust. The executor can choose to put some or all of the deceased spouse’s assets earmarked for the QTIP into the trust. (Choosing just some of them is called a “partial QTIP election.”) Once the election is made and the estate tax return is filed (nine months after the death, plus another six months from an extension), it’s irreversible. The executor should, of course, get expert advice before making a QTIP election.

Getting Expert Help With a QTIP

Preparing a QTIP trust (and then deciding, after one spouse dies, whether or not to use it) isn’t a do-it-yourself job. These trusts must be carefully drafted so that they don’t run afoul of IRS rules. But even if you could draw up the trust document yourself, you would still need good advice from an experienced lawyer before deciding whether or not a QTIP trust is right for your family. A QTIP is appropriate only in certain situations, and there may be other estate planning strategies that suit you better. An AB or bypass trust, for example, is simpler and may accomplish your goals.

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