A QTIP trust allows one to provide for a spouse after death and guarantee an inheritance for later beneficiaries. “QTIP” stands for Qualified Terminable Interest Property. It is a type of irrevocable trust often used in second marriages to manage one's estate. They are often used as part of an AB trust structure. QTIP trusts are authorized under Federal law in 26 USC 2056(b)(7)(A)-(B). They were authorized in Minnesota in 2014 in Minn. Stat. § 291.03, Subd. 1b.
How does a QTIP trust work?
A QTIP trust is essentially a four-step process:
- The grantor (person forming the trust) creates a testamentary irrevocable trust. A testamentary trust is one made at one's death. (It is possible to make a QTIP trust during one's lifetime, but the rules may be slightly different.)
- The trust is funded with an income producing asset. The trustee of the trust can be the surviving spouse, a financial institution, or another trusted individual.
- The income from the trust is paid to the surviving spouse for their lifetime. The surviving spouse is the “Lifetime Beneficiary.” The surviving spouse must have access to all of the income. They may have limited access to the principal provided it is limited to an ascertainable standard. (For example, health, education, maintenance, and support – “HEMS”.)
- When the surviving spouse dies, the trust assets pass to final beneficiaries. They are referred to as the “Remainder Beneficiaries.” The Remainder Beneficiaries are often the children of the grantor.
It is important that the assets in the QTIP trust are income producing, otherwise there will be no benefit to the surviving spouse. Rental properties are an excellent asset to include in a QTIP trust. Also, it may be necessary to agree to using a QTIP in a prenuptial agreement.
What are some of the benefits to using a QTIP?
There are a number of benefits to using QTIP trusts.
First is perhaps obvious but worth mentioning. It allows the grantor spouse to take care of the surviving spouse for his or her lifetime. It creates a guaranteed income, provided that the asset continues to create earnings. If the surviving spouse is not good with money, it provides income without paying a lump sum. Along the same lines, the assets in the QTIP are in an irrevocable trust. This means that it is sheltered from creditors.
The second primary benefit is that a QTIP trust guarantees an inheritance for the Remainder Beneficiaries. They are commonly used in second marriages when there are children from a first marriage. The grantor spouse could merely will everything to the surviving spouse and instruct them to leave the children of the first marriage whatever is left of the estate. But there is no guarantee that the surviving spouse will do this. The surviving spouse could spend the entirety of the inheritance and leave nothing for the children. Or the surviving spouse could remarry, have children, and cut out the original children from the will entirely. The QTIP trust provides an income to the surviving spouse during their lifetime and guarantees that the Remainder Beneficiaries get an inheritance.
Are there tax benefits to a QTIP trust?
There are two primary tax benefits to using QTIP trusts.
The first tax benefit is that assets in the QTIP trust are not included in the first spouse's (grantor's) estate. If the grantor has a substantial estate that is greater than the federal or Minnesota tax exemption, then whatever is put in the QTIP will be taken out of the estate. This works well when the surviving spouse does not have a substantial estate. It allows the first spouse to split their estate in two and use the unused exemption of the surviving spouse.
The second tax benefit is that because the assets in the QTIP trust are in the surviving spouse's estate, they will get a step-up in basis when the surviving spouse dies. If, for example, the assets in the QTIP are income producing properties, they likely will appreciate over time. The basis passed on to the Remainder Beneficiaries will thereby be higher when they receive it.
Qualified terminable interest trusts are a fantastic tool for planning one's estate. They allow someone to care for their spouse after death as well as guarantee an inheritance for others. If you want to learn more about how a QTIP trust can benefit you, please contact Signature Law for a free consultation.