The Qualified Terminable Interest Property (QTIP) Trust

Qtip (Photo credit: miggslives)

Often we come up against situations in planning finances for folks where some special tools are necessary.  One of those situations, quite common these days, is when one or both members of a couple has children by a prior marriage.  The situation brings about some interesting questions when considering how the marital assets will be divided when one member of the couple has passed on.

Daryl has three children by a prior marriage, and his wife Toni also has three children by a prior marriage.  Both Daryl and Toni have considerable assets from before their marriage – each has a investments and retirement accounts in their own name: Toni’s accounts are worth $350,000, and Daryl’s accounts are worth $300,000.  Given their lifestyle, they will not be needing much of their accounts early in retirement – but it’s quite likely that later in life they may need the accounts for medical care and potentially for nursing facility care.

Under common circumstances, when Daryl passes away, he will leave his assets to Toni, so that she can continue to live the lifestyle that she’s been accustomed to, as well as to ensure that she can afford adequate medical care later in life.  But if he bequeaths his entire estate directly to Toni, what happens when she passes?  Again, under common circumstances, she would pass along her estate to her children.  The problem is, by doing this, Daryl’s children don’t get a share of the estate at all!  How can this be straightened out?

One thing would be for Daryl to designate in his will that his estate would be split among Toni and his children, either equally or in some formula.  This gives rise to another problem though: what if the portion that he leaves to Toni isn’t enough to cover her living expenses and medical care?  His desire to make sure his kids got their fair share has left his wife possibly in dire straits when there was plenty of money available.

Another way to handle this would be for Toni and Daryl to each specify in their wills that the final estate, whichever of the two it would be, would be split among all six of their combined offspring.  The problem with this is that after Toni has passed away, Daryl decides to remarry again – and then when re-doing his will he cuts out Toni’s kids, who he has always had a contentious relationship with.

Enter the QTIP

Investopedia defines a Qualified Terminable Interest Property trust as follows:

A type of trust that enables the grantor to provide for a surviving spouse and also to maintain control of how the trust’s assets are distributed once the surviving spouse has also died. Income, and sometimes principal, generated from the trust is given to the surviving spouse to ensure that he or she is taken care of for the rest of his or her life.

This type of trust does exactly what we’re looking for:  after Daryl’s death, his assets become the property of his QTIP trust, which provides for Toni to be able to take income (and principal as necessary) from the assets in order to maintain her lifestyle.  Upon Toni’s passing, Daryl has declared that his three children will then receive an inheritance of the remaining assets in the QTIP.  Toni set up a QTIP for her estate as well, in the event that she pre-deceased Daryl, so that her children could receive a portion of the remaining estate upon Daryl’s death.

QTIP trusts can hold any type of asset, such as investment accounts, farmland, homes, and collectibles.  IRAs can be owned by a QTIP trust, but special care needs to be taken when setting up the trust to ensure that the marital deduction is preserved and that the income can be distributed as appropriate to the surviving spouse.  It’s usually simpler to pass an IRA directly to beneficiaries, or use a see-through trust to assist with the distribution process.

An important factor to consider when setting up these QTIP trusts is that a qualified trustee should be appointed to oversee the distribution of the assets.  This trustee should be a disinterested third party who would be in a position to make good decisions about when and how much of the trust is distributed to the surviving spouse.  Without this type of oversight, the survivor could diminish the QTIP first, before his or her own assets, thereby effectively disinheriting the decedent’s children.

You’d think it’s unlikely that something like this would happen, but as I’ve often said – you never really know someone until you are dividing an estate with them.  Once the original owner has died, the interested parties often cease to act like relatives and revert to the basics of the transaction: they’re just people splitting up money (or other assets).  It pays to get this right, in order to reduce the possibility of one or more parties taking advantage of others.