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:
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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.
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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.
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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.