As you find yourself approaching the later stages of life, you may start to think about what happens after you’re gone. What will your spouse do? Will your family be financially secure? These can be difficult thoughts to confront, but it’s only natural to want to ensure your loved ones are taken care of when you’re no longer around—and it’s a significant reason why people choose to create a trust as part of the estate planning process.
Not only can establishing a trust (or even multiple trusts) help keep your assets with your family and beneficiaries, but it can also reduce your estate tax liability. Arguably the most common types of trusts fall under the general category of spousal trusts, and among this category lies what’s known as a Qualified Terminable Interest Property (QTIP) Trust.
A Little Background: Marital Trusts
Before we dive into QTIP Trusts, let’s quickly recap Marital Trusts—also called A Trusts. In the broadest terms, a Marital Trust is an account set up to benefit your spouse. At the time of your passing, your assets are transferred into the trust account, and for the remainder of your spouse’s life, only they have access to the funds in the trust. But at the time of your spouse’s passing, they can decide to whom any remaining trust assets should transfer, like children, grandchildren, etc.
Marital Trusts also take advantage of the unlimited marital deduction to help you put off paying estate taxes. Typically, at the time of your passing, if your individual estate is more than the individual estate tax exemption amount, your estate would be taxed. In 2020, the federal estate tax exemption is $11,580,000, although, some states also have their own estate taxes with lower exemptions, so depending on the size of your estate, you could still have to pay taxes on it. But by establishing a Marital Trust and transferring those funds to your spouse, you can avoid that taxation at your death. However, the trust would then be subject to estate taxes after your spouse passes.
How QTIP Trusts Are Different
QTIP Trusts function almost the same as Marital Trusts. They’re both irrevocable trusts that can only name the surviving spouse as beneficiary during that spouse’s lifetime.
However, the major distinction between the two is that with a QTIP Trust, the grantor of the trust maintains control of it, even after death. This means that you’re giving your spouse all the income from the trust but can limit their right to the principal, meaning you can place restrictions on what the funds are used for and even how much can be taken out. Not only can you limit the extent to which your spouse can access the funds in the trust, but they also do not get to decide what happens to any remaining funds after they pass—that power still lies with you.
Although, while your spouse may not have control of the principal, the QTIP Trust is required to pay all income generated by the trust (e.g. dividends and interest) to them at least annually. This is what keeps trust-owned assets in the surviving spouse’s estate, even if they can’t dictate where trust assets will go at death. However, these payments will cease upon your spouse’s death, at which point remaining trust funds simply transfer to any other named beneficiaries.
The Advantages of QTIP Trusts
Aside from the assurance that your spouse is taken care of after you pass away, QTIP Trusts have some great benefits. Like Marital Trusts, QTIP Trusts allow you to take advantage of the unlimited marital deduction. Once again, this means that if you happen to have a particularly large estate (over the current $11,580,000 threshold), you can push off paying estate taxes until after your spouse passes away.
But unlike Marital Trusts, QTIP Trusts have a few nuances that make them particularly beneficial in specific situations. Since your spouse does not have control over the principal of the trust, you have the power to dictate any trustees (which could still be your spouse, but if this happens, principal distributions are typically limited to specific purposes) and even future beneficiaries. This means that while your spouse is receiving the income generated from the trust, they never actually have any ownership over the trust.
This can be particularly helpful if you’ve remarried. Say you have children from a previous marriage (and maybe they even have children) and want to ensure that they become the new beneficiaries of the trust after your new spouse passes. If you only establish a Marital Trust, there’s no way to be 100% certain that your kids and/or grandkids take over the trust in the future. Your new spouse would be free to name anyone they wanted as beneficiary after their passing—even their new spouse if they decide to remarry.
Additionally, by placing limits on the amount to which your spouse can access the trust funds, you can provide some protections from scams or incapacity. For instance, as your spouse advances in age, they may become more susceptible to scams. Maybe someone calls claiming to be a grandchild in need and looking for money. Maybe your spouse replies to a phishing email. If you limit their ability to access the funds—like they can only be used for health care, or they can only be accessed after being approved by a separate trustee—you can protect those funds from falling into the wrong hands.
Is a QTIP Trust Right for Me?
Estate planning is difficult on its own, and it can be even more difficult when you introduce things like trusts. The truth is, every situation is different, so something that might be right for your friends or other family members may not be right for your circumstances.
That’s why it’s important to include a financial advisor while crafting your estate plan. By being open and honest with them about your financial situation, they can help steer you down the path that’s right for you.
JD, MBA, Series 65 Advisory Registration† In her role as Vice President, Financial Advisor, Lane frequently draws on her extensive experience advising high net worth clients on complex legal matters. Before joining the financial services industry, she worked as a senior associate for the law firm of Rutkin, Oldham & Griffin, LLC, litigating high net worth dissolution and child custody matters. Lane joined Wealth Enhancement Group through the 2016 merger with HHG &...Read More