QTIP trusts allow a married adult to provide lifetime income for their surviving spouse without jeopardizing the inheritance intended for children from a previous relationship.
QTIP trusts also provide flexibility for the decedent’s executor (referred to as the personal representative in Arizona). If the family’s financial situation significantly changes or estate tax laws necessitate an alternate strategy, the personal representative can elect not to execute the QTIP trust.
Scratching your head over what a QTIP trust actually is? Don’t worry — in this article, we’ll cover everything you need to know, including:
- What is a QTIP trust?
- How does a QTIP trust work?
- When to use a QTIP trust
- How an attorney can help with QTIP trusts
- Frequently asked questions about QTIP trusts
- What to do if you need help with a QTIP trust
QTIP (Qualified Terminal Interest Property) Trusts
A Qualified Terminable Interest Property Trust — commonly referred to as a QTIP trust — is a legal trust that qualifies for the IRS marital deduction. QTIP trusts allow a married adult to create a life estate for their surviving spouse without triggering the federal gift tax.
Under the terms of the QTIP trust agreement, the surviving spouse will receive interest income from the trust during their lifetime. The surviving spouse will also enjoy access to real property owned by the trust, such as the family home, vacation homes, vehicles, etc.
What makes a QTIP trust interesting is that it does not grant the surviving spouse ownership of the principal value of the assets held in trust. Instead, the trustee will manage the assets until the surviving spouse passes away, at which point the assets will transfer to the final beneficiaries (usually the decedent’s children).
In addition to preserving the principal value of assets for the final beneficiaries, QTIP trusts also provide more flexibility than a standard revocable trust. Where the latter cannot be changed once the owner passes away, the decedent’s personal representative can elect not to execute a QTIP trust if the family’s financial situation or estate tax laws necessitate a different strategy.
How QTIP Trusts Work
Let’s take a look at QTIP trusts in the context of an example.
When Alvin and Betty get married, they each have a child from a previous marriage. The newlyweds want to ensure their spouse is provided for after they die, but they also want to ensure their biological child receives a full inheritance.
As part of their estate plan, Alvin and Betty each draft a QTIP trust.
When Alvin passes away, his share of the joint estate (50% under Arizona law) along with his personal property transfers to a QTIP trust. Betty gets to stay in the family home, though she’s not allowed to sell it or transfer ownership to anyone else. Betty also receives income from the trust’s investments, though she cannot access the principal value.
When Betty passes away, Alvin’s biological child — who is listed as the final beneficiary of the QTIP trust — will receive full ownership of the assets. The trust will immediately liquidate and close if the child is an adult, or it’ll stay in effect until the minor child turns 18.
Note how the QTIP trust preserve’s Alvin’s child’s inheritance, even if Betty gets remarried, a new spouse moves into the family home, or Betty has more children.
When to Use a QTIP Trust
QTIP trusts are most commonly used by remarried adults, especially those whose families are concerned that a step-parent will squander their inheritance. The QTIP trust strikes an ideal balance between providing for the new spouse and preserving the principal value of the children’s inheritance.
QTIP trusts are generally formed after the wedding, as you cannot take advantage of the marital tax deduction when you’re not married. As such, QTIP trusts are not intended to replace a prenuptial agreement.
How Working with an Attorney Can Help
Trusts are complex estate planning tools. You can set one up on your own, but it’s a lot easier to do with the help of an experienced estate planning attorney.
More importantly, QTIP trusts are just one piece of the puzzle when it comes to estate planning. An experienced attorney can help you create and implement a comprehensive estate plan, including a will, power of attorney, and possibly other types of trusts.
FAQs about QTIP estate planning in Arizona
Q: Is a QTIP trust included in the gross estate?
When the first spouse passes away, the assets in the QTIP trust qualify for the marital deduction and are excluded from the decedent’s estate and gift taxes. When the second spouse passes away, the trust assets will be considered part of the gross estate.
Keep in mind that you only need to worry about estate taxes for joint estates worth more than $11.4 million as of 2019. As such, most Americans don’t need to worry about the gross value of their joint estate.
Q: Does a QTIP trust get a step up in basis?
Under current US tax law, QTIP trusts may benefit from a double step-up. That means there will be an initial step-up when the first spouse passes away and the assets are transferred to the trust, followed by a second step-up when the surviving spouse passes away.
Q: Does a QTIP trust avoid probate?
All trusts are designed to avoid probate. That means QTIP trusts don’t need to be probated when the first spouse passes away or when the surviving spouse passes away. Instead, the trustee will transfer the assets directly to the final beneficiary.
What to Do if You Need Help with QTIP Estate Planning in Arizona
Before you set up a QTIP trust, it’s important to create a comprehensive estate plan with the help of an experienced attorney.
Schedule an appointment to meet with an attorney and discuss your goals. If the attorney agrees that a QTIP trust makes sense for your situation, they’ll draft the agreement and ensure everything is in order so that you don’t risk the court invalidating your trust down the road if someone contests it.
Call our Arizona Estate Planning team at (480)467-4325 to discuss your case today.