|
QTIP TRUST VERSUS
OUTRIGHT GIFT: THE BASIC RATIONALE
INTRODUCTION:
In the last decade
or so the number of married couples electing to utilize the Qualified
Terminal Interest Plan (“QTIP”) for their estate planning has increased
significantly. This estate planning tool has become a staple for the
typical middle class family yet is not necessarily fully understood by
many of the people confronting the issue of how to structure their Wills
and Trusts.
This article shall
discuss the basic pros and cons and purposes of the QTIP Trust. It is
presumed that the reader will have already read our basic article on
estate planning,
Wills and Trusts.
THE MARITAL DEDUCTION
AND NEED FOR QTIPS
Estate taxes are the
federal tax imposed upon the privilege of leaving one’s assets to
another at death. While the estate tax is currently in flux and the rate
and the exemption is altering every year or so, the likely bracket faced
by most Californians who own a home is over thirty five percent of all
sums passed above two million dollars (increasing to 3.5 million in
2009). Since most homes in the Bay Area remain worth well over a million
dollars, even a typical middle class family faces hundreds of thousands
of dollars in taxes upon the death of a spouse.
Much of estate
planning involves minimizing the taxes that death can create. A very
useful tool is the marital deduction, a deduction that eliminates
from estate tax any sums, no matter how great, going outright to a
spouse. Thus, even if one dies with a ten million dollar estate, no
estate taxes would be due upon the death of the first spouse if the
estate goes entirely to the surviving spouse…though taxes would be due
upon the death of the surviving spouse.
This valuable
deduction makes a tremendous difference for most couples but there is
one catch-to qualify for a marital deduction, a gift must be made
outright. It can not be in trust and it cannot be contingent. The spouse
must simply receive the gift as a full gift with total control
Why is that a
problem?
Once one inherits an
asset outright, one is free to do anything they wish with it. That is
the essence of outright ownership. However, for many parents, they wish
to be sure that at least a portion of their estate eventually goes to
their children or grandchildren. While they wish to protect the
surviving spouse and want to make sure the spouse has access to the
deceased spouse’s assets if in need, upon the death of the surviving
spouse they want the remaining assets to go to the children or
grandchildren or perhaps some other relative.
The fear, often
unspoken, is that the surviving spouse will eventually marry or become
involved with someone new and that the entire estate will eventually go
to that new person rather than the children. As one client stated to the
writer, “If he wants to marry Britney Spears, that’s his business…but I
want to make sure my children and not Britney gets what’s left in my
estate.”
The obvious
solution…create a trust in which the surviving spouse gets income and
access if need and upon his or her death, the remaining assets go to the
children…is NOT an outright gift and would not qualify for the marital
deduction. Thus, putting three million dollars into that type of spousal
trust would result in taxes of more than five hundred thousand while an
outright gift of that same group of assets would result in no taxes.
Is protecting your
children from Britney worth hundreds of thousands of dollars in
additional taxes? THAT was the question presented to the typical married
couple…until QTIPS were invented.
QTIPS: WHAT DO THEY DO?
As an exception to
the rule that assets only qualify for the marital deduction if they are
an outright gift, a gift that qualifies as a QTIP is still deductible
under the marital deduction if it adheres to specific statutory criteria
which provide that:
-
The spouse must
be the income beneficiary for all sums placed in the QTIP account
for the spouse’s entire life, payments of all income to be made no
less than quarterly.
-
It is possible
but not necessary that the surviving spouse should also have the
right to invade the corpus (principle) for criteria based on need.
-
Upon the death
of the surviving spouse, the remaining corpus may be distributed as
the person creating the trust wishes.
There are other
relatively minor criteria and an experienced attorney should be
consulted before creating the document, but the general theme-income for
life, then remainder to the children-is a favorite one of many couples.
And…the marital deduction is saved.
It should be noted
that a trust is not required to have a QTIP gift. However, almost all
QTIP gifts are made in the intervivos trust arrangement now utilized by
so many married couples.
PROS AND CONS
While the QTIP does
achieve some protection of the next generation, it must be noted that
there will be a need for a trust structure in most circumstances and
that the surviving spouse will face restriction on access to the sums
put into the trust. Recall that in California, a community property
state, half of what a married couple owns is already the property of the
surviving spouse. Thus the spouse creating a QTIP plan only can control
half of the joint property-but that control is still a definite
restriction on the surviving spouse’s freedom of action.
More than once this
writer, as a trustee, had to tell a surviving spouse that some purchase
or business investment simply was not appropriate for the Trust and
quite often the surviving spouse is less than happy that property he or
she once thought of as eventually going entirely to him or her…is now
protected in a trust.
But if one wants to
guaranty that some inheritance goes to the next generation-while making
sure the surviving spouse will be protected during his or her life…the
QTIP is usually the best tool in the estate planning arsenal. |
