By having the assets from the estate go into a QDOT instead of directly to a surviving spouse, the estate taxes due are deferred during the non-citizen spouse’s lifetime. The surviving non-citizen spouse can then receive income annually from the trust. If there’s an emergency or “hardship” (as defined by the IRS) the surviving spouse can also receive principal from the trust. However, estate taxes would need to be paid on the amount of principal withdrawn during the spouse’s life if not withdrawn due to hardship.
There are pros and cons to a QDOT.
It’s up to the client and his or her spouse as to whether these are pros or cons, but they are factors to consider:
- While a QDOT defers the surviving non-citizen spouse from owing federal estate taxes, it does limit the spouse’s access to the funds, except as already stated in an emergency or hardship situation.
- There are specific requirements for trustees of a QDOT. The non-citizen spouse cannot be a trustee and at least one of the trustees must be a U.S. citizen or a U.S. corporation.
- If the surviving non-citizen spouse wanted to live outside the United States, the funds in the QDOT must remain in the U.S. They are not transportable.
- A QDOT defers only estate taxes. When the surviving spouse dies, assets remaining are subject to estate tax based on the original estate tax exposure, and may also be taxable in the spouse’s estate with some relief for the deceased spouse’s estate tax liability. Any remaining principal will be distributed to the beneficiaries as directed in the trust document.
Don’t overlook the benefits of a life insurance policy.
A QDOT can be a smart way to provide for a surviving non-U.S. citizen spouse in the long-term. However, a life insurance policy can offer these benefits:
- A life insurance policy can be purchased to help cover any estimated estate tax exposure.
- On the downside, if the deceased spouse is the owner of the policy and is a U.S. citizen or resident, then the death benefit is considered part of the estate and will be subject to the U.S. estate tax considerations prior to the death benefit being paid out to the beneficiary.
- On the upside, a life insurance policy can help ensure that money shows up for the surviving spouse at a time when he or she may need it the most.
- In addition, the death benefit is generally free from federal income taxes and without the disbursement restrictions of a QDOT.
Estate planning when one of the spouses is a non-U.S. citizen requires some special considerations. It is important to weigh the various alternatives to find the smartest solution that would save a lot of financial heartache and headaches later on based on the client’s individual situation.