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What is a Qualified Terminable Interest Property Trust?


These trusts are especially useful in second marriages.

This oddly named trust is used by many wealthy couples. It serves two main purposes:

A: It lets you put strings on your property, rather than leaving it to your spouse outright—useful if you’re in a second marriage and want to provide for both your current spouse and your children from a previous marriage.

B: When one spouse dies, it lets the survivor decide how much (if any) of the deceased spouse’s property should be held in trust to maximize estate tax savings–useful in these times of continual change and uncertainty about the estate tax.

QTIP, by the way, is an abbreviation for “Qualified Terminable Interest Property.” You can see why people prefer the catchy acronym to the full name.

How a QTIP Trust Works to Control Property

Each spouse can set up a QTIP trust, leaving assets to the other in trust. When the first spouse dies, the survivor gets what’s called a “life estate” in the assets that are left to the QTIP trust—that is, the survivor is entitled to any income the assets produce, and in the case of real estate, to its use. Only the surviving spouse can be named as the life beneficiary. The survivor does not, however, have full ownership of the trust assets and cannot sell them or give them away.

When the second spouse dies, trust assets go to the “final beneficiary” named in the trust. Commonly, the final beneficiaries are children from the other spouse’s previous marriage.

Main Points of a QTIP

* A qualified terminable interest property (QTIP) trust allows an individual, called the grantor, to leave assets for a surviving spouse and also determine how the trust’s assets are split up after the surviving spouse dies.

*Under a QTIP, income is paid to a surviving spouse, while the balance of the funds is held in trust until that spouse’s death, at which point it is then paid out to the beneficiaries specified by the grantor.

* QTIP trusts are put to use in estate planning and are especially useful when beneficiaries exist from a previous marriage but the grantor dies before a subsequent spouse does.

* With a QTIP, estate tax is not assessed at the point of the first spouse’s death, but is instead determined after the second spouse has passed.

When you set up a QTIP, you must name a trustee as well as beneficiaries. You can name your spouse to be the trustee, choose one of your adult children, or pick a disinterested third party. Professionals will serve as trustees for a fee (usually a percentage of the value of trust assets), but only if the value of the trust assets is large enough.

Making it clear that your children from a previous marriage will ultimately inherit assets can be a good way to reduce family tension. When you spell out the arrangements in a solid estate plan, your children can relax. They don’t have to be afraid that their stepparent will squander the family inheritance, leave it all to his or her own relatives, or remarry and leave it to a new spouse.

By contrast, simply leaving all your assets to your spouse, trusting him or her to provide for your children from a previous marriage, can be asking for trouble. Your children may worry—with or without justification—that they’ll be left out in the cold.

Of course, no piece of paper can ever eliminate all traces of family discord. Children may keep a suspicious eye on a stepparent’s management of QTIP assets, wishing that investment strategy would be focus on producing income (which goes to the surviving spouse) and not on growth (which will eventually benefit them). You and your spouse are the only ones who can decide whether a QTIP trust arrangement would be likely to improve or hurt relations between your spouse and your children.

How a QTIP Trust Works to Defer Estate Tax

A QTIP trust doesn’t eliminate estate tax; it postpones it until the death of the second spouse. If you create a QTIP trust, then at your death no estate tax is due on the assets that go into the trust. The assets qualify for the unlimited marital deduction, which lets all property, regardless of value, pass to a surviving spouse free of estate tax.

You can get the estate tax benefits of a QTIP trust only if your spouse is a U.S. citizen. The marital deduction (the rule that lets surviving spouses inherit any amount from the deceased spouse free of estate tax) is key to the QTIP, and it doesn’t apply to noncitizens. You may want to consider another kind of trust, the QDOT or Qualified Domestic Trust, which may help you accomplish your tax-related goals.

Legally married same-sex couples could not, at one time, take advantage of QTIP trusts. But since June 2013, when the U.S. Supreme Court found parts of the federal Defense of Marriage Act (DOMA) unconstitutional, the IRS has recognized the legal marriages of same-sex couples, regardless of what state the couples live in. These couples may claim all benefits granted to married couples under the tax law, including the marital deduction.

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