Qualified Terminable Interest Property Trust Explained

A qualified terminable interest property (QTIP) trust is a legal document that enables a person to provide for his surviving spouse, and also to retain control over the assets' distribution after the surviving spouse also passes away. This Buzzle article will explain this concept further.
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Qualified terminable interest property trust
"With a QTIP trust, you know where the property is going after the death of the spouse who dies first. There is almost always concern about kids of a first marriage. The creator of the trust, in effect, gets to decide who gets what."
― Eric W. Hager, trusts and estates lawyer, Davidson, Dawson & Clark, New York
Married couples generally plan ownership of their assests together. While doing so, it is very important to plan and organize things in an efficient manner to avoid problems later. Therefore, when you plan, you need to take into account whether your assets are owned individually or jointly. Another important thing is to keep your spouse aware of every little financial and legal decision involving the two of you. Especially in cases where only one partner is handling such affairs. Also, if one of them doesn't earn, it is essential to secure enough money for him/her so that he/she does not have a problem in the future (if, unfortunately, one of you passes away).

An even more important point is to make sure no other party (mostly the second spouse of your surviving spouse) takes control of the estate. This can be ensured by a qualified terminable interest property (QTIP) trust, which is explained in detail in the paragraphs below.

How Does a QTIP Trust Work?
  • As mentioned earlier, a QTIP trust is a document that ensures that your spouse receives a comfortable income after your death (untimely or otherwise).
  • The restriction here is that, your spouse will not have complete control of the assets.
  • In other words, your partner will receive a regular income from the fund, but will not have any rights regarding the distribution of the assets. She cannot even withdraw the principal.
  • If your surviving spouse remarries, neither she nor her current spouse can control your assets.
  • After her death, the assets will be distributed as per the conditions stated at the formation of the contract.
  • Thus, QTIP is a way of ensuring that you remain in control of your estate even after you leave this world. Also, it allows you to give your estate to your spouse without incurring the federal gift tax.

Legal Terms Explained

Marital Deduction

It is a law that allows a person to transfer his estate to his spouse with either less or no imposed tax. Generally, when a person leaves his possessions to others after his death, it is subject to federal estate tax if the total estate value exceeds the applicable exclusion amount under the law. But, when the same is passed on to a surviving spouse, under marital deduction, spouses can transfer the estate between themselves, during life or at death, without being subject to the federal gift tax.

Terminable Interest

It is an interest in a property that can expire due to failure of an event to occur, lapsed time, or the termination of the occurrence of any event in the future. For instance, if a man leaves his estate to his wife, only on the condition that she does not remarry. If she does so, the estate will pass on to the man's brother. In this case, the wife has a terminable interest in the property, which will not qualify for marital deduction.

Qualified Terminable Interest

The law allows certain kind of terminable interests to qualify for marital deduction. For this, certain legal terms and conditions have to be met. Also, the executor of the deceased spouse's estate must elect to take the marital deduction for a terminable interest, that must be 'qualified'. This can be done in case of the following two types of interests.

  1. Lifetime Income Interests
    Here, the surviving spouse should have the right to all income from the estate for as long as she (or he) lives, and this income must be paid annually/quarterly, or at other periodic frequent intervals. And no one (including the surviving spouse) must have the power to transfer the estate to anyone other than the surviving spouse. Also, the deceased spouse's executor must volunteer to take the marital deduction for the estate on the federal estate tax return.
  2. Income Interests in Charitable Remainder Trusts
    If the spouse is the beneficiary of a charitable trust, the income interest will eventually terminate. At that time, the charity will be liable to have full interest in the property, and the spouse will not have any power to dispose the property. But if the charity and spouse are the only beneficiaries, the trust can come under marital deduction. An important point to remember here is that the spouse is not required to have a lifetime income interest, since it could terminate after a period of years, when the charity is scheduled to take over.

QTIP Trust Benefits
  • It is a way to ensure that one's spouse is taken care of after one's death, and still allow the grantor to have control over asset distribution.
  • It allows the person to dictate in the QTIP trust, the person to whom the assets will go at the death of the surviving spouse.
  • The surviving spouse is assured of receiving all income from the QTIP trust and may also be given other rights.
  • It also allows both spouses to make use of their applicable exclusion amounts.
  • Since you do not know when you are likely to die, you may not know what your estate tax situation will be at the time the trust is put into effect. Therefore, it is essential that your executor makes a decision between choosing a marital deduction or forgoing it. In other words, the trust will allow the executor to lower the total estate tax, which will be paid by both, the husband and wife. This can be done by reducing the tax on some of the assets that are transferred to the spouse.
  • Since the trust contains restrictive ownership provisions, you are assured that the property will pass on to your children or family, and not any third party.
  • Sometimes, it may not be feasible to leave the property to a surviving spouse, the reasons being, that the spouse is aged or not well-versed in financial affairs or property management. The QTIP trust allows property to be managed for the spouse's benefit without these burdens.

QTIP Trust Examples

Example 1

Let's assume, Robert and Susan are a couple with a single child, and that Robert establishes a QTIP trust. After his death, all the property would go to Susan. If Susan remarries a man with 2 kids and now intends to distribute that income among her new husband and all her children, she cannot do so, since she does not have any control over the trust. All she will get is a regular income to cover her expenses. After her death, the remaining property would pass on to her child from Robert or some charity, or whatever Robert has chosen to put in the trust as a condition. Thus, Robert is able to secure his wife and child and at the same time, divide his financial assets even after his death.

Example 2

Let's say, John has set up a QTIP trust fund and named his two children as beneficiaries. Ideally, after his death, his wife will inherit the income. And, when she dies, the property would automatically be transferred to his children. However, using one of the benefits of this trust (as mentioned above), if John wishes that his wife distribute the assets accordingly, he has the right to do so, by mentioning the same in the trust. A provision needs to be added to the trust, which designates this right to his wife and gives her the flexibility to distribute the assets to their children, in case their needs change after his death.

A QTIP trust is considered an important component of any estate plan. This is especially valid in situations where there is a question of flexibility regarding the timing of estate tax payments and the assurance that assets will ultimately pass to your family. It is essential for every married couple to make a QTIP trust fund so that the property as well as the family is protected and secured from outsiders.
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Published: August 19, 2014
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