A “Qualified Terminable Interest Property Trust”, or “QTIP” for short, allows a spouse to give a life estate in property to the other spouse in order to avoid the federal gift tax. A Life estate is a certain joint ownership of a household. An individual owns this for the duration of their lifetime only. With a life estate, beneficiaries cannot sell the property prior to the beneficiary’s death.
A QTIP allows someone to provide income for the surviving spouse as well as passing on property and other assets to different beneficiaries. With this type of trust, the surviving spouse is paid an income. The principal assets are inherited by someone of your choosing though. When one spouse dies, assets transfer to the QTIP trust and no estate taxes are collected at this time.
How Does A Qualified Terminable Interest Property Trust Work?
If you share a main residence or property with your spouse and would like to take care of them when you pass away, setting up a QTIP is a great idea. How does a qualified terminable interest property trust work though? How will my spouse get benefits and generate income from the trust? Let’s find out:
How Do You Create A QTIP?
There are two ways that you can create a QTIP. You can create this while you are alive, or choose to have assets transferred via a will when you die. Either way it is irrevocable and cannot be modified. For the sake of this example, we will focus on the trust rather than the will route.
The rules for QTIP trust establishment during your life may differ slightly. You should consult with an estate attorney, this is highly recommended.
You should start by naming a trustee and two beneficiaries. The reason why there are two types of beneficiaries needed is because one is obviously your surviving spouse. The other is the beneficiary you intend to get the remaining assets.
- Lifetime Beneficiary: The surviving spouse who receives trust income over their lifetime, with limited access to some of the assets in the trust, is known as the Lifetime Beneficiary
- Remainder Beneficiary: The person who receives the remainder of the trusts assets when the surviving spouse passes away is known as the Remainder Beneficiary
Trust Income With A QTIP
Since the surviving spouse will have limited access to the principal (with certain exceptions, special circumstances may include health, education or maintenance costs), the assets within the QTIP must generate income in order for it to work. A QTIP will not really work if the assets it holds do not generate income, the trust should include income generating property — such as investment accounts or rental properties.
If you are setting up a QTIP and do not have income producing assets, the assets can be sold and converted into something income generating. With a QTIP, you can specify a set amount for the spouse to receive — either a percentage or fixed amount. Payments will be made similar to the issuance of stock dividends. It is important to note that payments will cease once the surviving spouse has died as they are non-transferable. Upon death, assets will go to the designated beneficiaries.
Does This Qualify For The Marital Deduction?
A QTIP is the type of trust that qualifies for the Marital Deduction. When set up correctly, according to the IRS’s terms, the assets can qualify for the marital deduction. The marital deduction minimizes the estate tax since the trust assets inherited by the spouse are typically not taxed. If you have property transferred in a QTIP, the trustee must claim the marital deduction on the federal estate tax return by listing the qualified property on Schedule M (one page amendment to your 1040 return).
Estate taxes will be deferred until the death of a surviving spouse, when at that point, they will then be incorporated into their taxable estate. It is important to note that only estates over the exemption amount will need to pay that tax however, the federal tax exemption for 2020 is $11.58M
In order for this to work, one spouse must give the other spouse the assets completely. The inverse of this is not true however, the surviving spouse does not have complete access to the assets in the trust. They do not actually inherit the assets, as they are not the remainder beneficiary. A QTIP trust has to be structured to provide income in order to show a “qualified lifetime interest” for the surviving spouse.
An example situation where a qualified terminable interest property trust would be applicable is as follows. If you put your primary residence and other assets into a QTIP trust and with your spouse as the Lifetime Beneficiary. You may designate your son/daughter as the Remainder Beneficiary. When you die, your surviving spouse can continue to live in the house while receiving income on the QTIP trust. However, they cannot sell the house since the trust owns it, not the spouse.
Pros and Cons Of A QTIP
Certainly there are benefits and disadvantages with a QTIP, as with any type of trust. Some issues encountered are inherent to the type of trust that they are. Others are specific to this type of trust alone. Let’s compare the pros and cons of a QTIP trust:
Pros of QTIPs
A QTIP Trust is a great tool for someone to ensure that their spouses are well taken care of. This also protects the following generation as well. Some of the pros for this type of trust include:
- Simpler type of irrevocable trust that provides immediate support for your spouse
- Estate taxes can be deferred (if they are even applicable)
- Protection from creditors. You have less risk of a lawsuit or debt collectors getting access to the funds since it is surviving spouses only income
Cons of QTIPs
Some of the downsides to this type of trust depends upon which beneficiary you are asking. It may be different for the lifetime beneficiary compared to the remainder beneficiary. Some of the cons for this type of trust include:
- Complicated and require maintenance, as with any trust that is more long term
- Surviving spouse is not owner of the property within the trust
- Remainder beneficiary does not have access to the assets until the surviving spouse passes away
Final Thoughts: Start Planning Your Estate
Why should you choose a QTIP? If you are married for one. If you want to make sure that your husband or wife is prepared for life after you are gone. A QTIP is a useful vessel for achieving this goal.
This is similar to a marital trust in that it holds assets of the first spouse who passed away. However, there are more restrictions with a QTIP. It is best to check with a financial advisor if you want to set one up. They may be able to provide valuable guidance to see if this makes sense for you and your family.