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Financial Planning > Trusts and Estates > Trust Planning

Planning For The Surviving Spouse With A QTIP Trust

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While an estate plan will often concentrate on the credit shelter trust or B trust side of an A-B trust, advisors should also give attention to what will be left over to a surviving spouse under the unlimited marital deduction.

In today’s world of multiple marriages and stories of seniors passing on millions to their last caregivers and disinheriting their children, determining what happens to the entire estate should be a major part of the planning discussion.

A qualified terminable interest property (QTIP) trust could be used as an estate planning tool for married couples where, at death, one spouse passes assets to the surviving spouse but maintains some control over the assets during the life of the survivor as well as after the survivor’s death. QTIPs are often exercised in second marriage scenarios where the wealthier spouse wants to allow for the survivor to live comfortably after his or her death, but also wants the remainder to go to the children from the first marriage.

QTIPs may also be used to protect a financially unsophisticated spouse from being taken advantage of or frittering away an inheritance due to a lack of understanding of the financial markets. A properly drawn QTIP will better protect a frail or failing elderly spouse from being taken advantage of by predators posing as caregivers.

A QTIP trust is similar to a B trust, but there are significant differences. The primary goal of the B trust is to leave a legacy to beneficiaries while also providing for the surviving spouse if necessary. The B trust is created to minimize the impact of estate taxes on the inheritance. Conversely, a QTIP trust’s primary objective is to provide for the survivor while not allowing total control of the assets.

Usually a B trust is funded with the federal excluded amount; the remainder (under the marital exemption) flows into the QTIP trust. The downside is that the QTIP trust assets are included in the surviving spouse’s estate even though the trust is irrevocable and the survivor has no ability to change who will receive the remainder from the trust.

One factor to consider affects many trustees: the effect of taxes on growth in the trust. If growth occurs inside an income-generating program, the QTIP trust may be required to pay income tax at the highest individual rate if the income is not distributed to the surviving spouse. While municipal bonds, CDs, mutual funds and individual stocks can be part of the income generating mix, another solution would have the trustee purchase a deferred variable annuity. In this way, the trust may be able to avoid paying income tax on any gains within the annuity until it is distributed.

As in any trust scenario, however, a question then arises: How does one treat the tax deferral when using an annuity as a funding product? According to Section 72(u) of the Internal Revenue Code an annuity owned by a non-natural person cannot receive tax deferral through a deferred annuity.

However, Section 72(u)(1) provides an exception for an annuity owned by a trust or other entity holding an annuity as an “agent for a natural person.” Whether or not the trust qualifies for the exception needs to be determined by a professional advisor who is familiar with both the trust and applicable tax law.

Let’s assume that the above criteria are met and that the deferred variable annuity would receive tax deferral. Is that the end of the story? It shouldn’t be. Tax deferral can be important, especially in cases where the investments in the trust are performing well and can be used to provide income for the surviving spouse.

However the portion of the portfolio invested in the deferred VA could play a critical role in a down or flat market scenario. This is where it is critical that the trustee and the financial advisor have clear communications regarding the features and benefits of the annuity contract.

The sometimes conflicting needs of the trust beneficiaries (income beneficiaries and remainder beneficiaries) can often be addressed with a combination of investments, including living and death benefits offered by deferred variable annuities. These benefits are generally available to the client at an additional cost. When a strong network of trust exists between the trustee, the estate planner and the financial advisor, the opportunity to provide creative strategies to meet the client’s needs grows exponentially.


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