When it comes to estate planning, married couples have a few different options. One popular option is the QTIP trust. But what is a QTIP trust, and how can it benefit married couples? This blog post will discuss the benefits of QTIP and lifetime QTIP trusts and see how they can help spouses live in financial harmony.
What is a Qualified Terminable Interest Property (QTIP) Trust?
When it comes to estate planning for married couples, there are a lot of potential problems that can arise. What happens if one spouse is significantly wealthier than the other? How do you make sure your assets go to the right people?
In estate planning, a “QTIP Trust” (qualified terminable interest property trust) allows a wealthier spouse to transfer an unrestricted amount of assets into a trust to benefit their less affluent spouse. The assets transferred are free from estate and gift taxes.
How the Marital Deduction Works with a QTIP Trust Strategy
A common estate planning strategy for high net-worth couples has been to use a QTIP Marital Trust after the first death under the “AB Trust” structure:
After the first spouse dies, the “B Trust” holds an amount equal to the federal estate tax exemption. The federal estate taxes only kick in after the first $12.92 million in 2023.
With the AB QTIP Trust strategy, the “A Trust” holds the excess above the tax law amount. The “A Trust” is, in fact, a “QTIP Trust,” which qualifies for the unlimited marital deduction. This unlimited deduction means property passing into the trust will not be subject to estate taxes until the surviving spouse dies.
How the Tax Advantages of a QTIP Trust Work in Real Life
Let’s look at a hypothetical couple to understand better how a terminable interest property (QTIP) trust works.
Joe and Jean are in a second marriage. Each has their own children, and each owns disproportionate estates. Joe is worth $2 million, and Jean is worth $20 million.
With the AB Trust strategy, if Jean dies first, $12.92 million pours into the B Trust. $7.08 million pours into the A Trust.
No estate tax is due at Jean’s death since:
- The B Trust uses up her federal estate tax exemption.
- The A Trust qualifies for the unlimited marital deduction.
However, a marital couple creates a QTIP trust to take effect after the first spouse’s death, leaving assets to the spouse beneficiary.
Another option is creating a Lifetime QTIP trust. But how does the lifetime QTIP trust work?
Lifetime QTIP Trust Benefits
You can draw up a Lifetime QTIP Trust created and funded with gifts from the wealthier spouse. Those assets qualify for the unlimited marital deduction while both spouses are living.
For married couples whose estates are uneven, the wealthier spouse often wants to provide for the less affluent spouse. However, they also want to ensure their assets ultimately pass to their own heirs.
A lifetime QTIP trust offers many benefits for a blended family. It allows the wealthier spouse to plan for their living spouse, but maintains control over who receives the remaining assets after the second spouse’s death. In this way, the more affluent spouse in a second marriage can work to protect the less wealthy spouse while living and also provide for their named beneficiaries, such as their children from a first marriage.
Creating a Lifetime QTIP Trust offers the following benefits to our hypothetical couple:
- During Joe’s lifetime, he receives all the trust income. Depending on the trust’s design, he may receive principal interest income for limited purposes (such as health, education, and maintenance). Thus this spouse receives lifetime income from their wealthier spouse.
- When Joe dies, the assets remaining in the trust pour into his estate, using his federal estate tax exemption.
- If Joe dies first, the remaining trust funds may continue in an asset-protected, lifetime trust for Jean’s benefit (subject to applicable state law).
- Even though Jean initially funded the trust, the remaining assets are not a part of her estate when she dies, regardless of the order of death.
- After both spouses die, the trust balance passes according to Jean’s wishes.
Portability, Estate Taxes, and Your Marriage
If you die in 2026 or after, there is a possibility the estate tax exemption could be back down to $5 million adjusted for inflation. Unfortunately, without a crystal ball, there is no way to know the exemption amount in the future.
However, portability is a handy tool in our belts to help us battle this uncertainty.
Portability allows a surviving spouse to use their deceased spouse’s unused exclusion (DSUE) for either gift or estate tax reduction. The technical term for the unused spousal estate exemption is the deceased spousal unused exclusion amount (DSUE).
Married couples can avoid estate taxes at the first spouse’s death via an unlimited marital deduction. In the past, to take advantage of a spouse’s unused exemption amount, taxpayers had to establish credit shelter trusts to protect the first spouse’s exemption amount.
But things changed in the 2010s. Federal acts passed, allowing one spouse’s unused exemption amount to be portable to the other spouse. Portability enables taxpayers to use their deceased spouse’s unused exemption amount PLUS their own exemption amounts, reducing the estate asset amount subject to estate taxes at their own deaths.
The DSUE means that the surviving spouse has their own exclusion plus whatever is left over from their deceased spouse. However, to take advantage of the DSUE, you must file an estate tax return (Form 706) within 5 years of the first spouse’s passing.
Without portability, an additional $5,000,000 of assets may be included in a surviving spouse’s estate and subject to federal taxes! Without filing for your DSUE, as the surviving spouse, you only have your own exclusion amount.
Note: You can only use the DSUE for your most recent deceased spouse. If you remarry, you must use the DSUE from your first spouse before your second spouse dies, or else you will lose it.
What Happens When the Surviving Spouse Passes Away?
With a Lifetime QTIP Trust, after both spouses die, the balance of the trust goes to the beneficiaries named by the wealthy spouse.
Lifetime QTIPs protect the more affluent spouse’s beneficiaries so that trust assets can go to their children or other heirs. The wealthier spouse can leave assets so that the final beneficiaries are of their own choosing. However, the QTIP trust benefits their spouse first.
With QTIP Trusts, many blended families can keep more peace and love within their family relationships with less worry about will contests or family strife after deaths in the family. With other family members sure of their future inheritance and your careful estate planning, it’s possible to keep children from a previous marriage happy while also benefiting a second spouse.
Our Experienced Estate Planning and Trusts Attorneys Can Help
Like other estate planning tools and strategies, lifetime QTIP Trusts are not “one size fits all.” An experienced estate planning Trusts attorney can specifically tailor trusts to suit each couple’s unique goals, family dynamics, and financial situation.
Get in touch with us at Vail Gardner Law if you think you and your spouse might benefit from a Lifetime QTIP Trust. We’ll be glad to talk with you about what types of trusts can help you meet your financial and family inheritance goals.