A trust is a legal agreement that creates a three party relationship by which fiduciary control of property, often a sum of money,  is given by an individual, called the “trustor” or “settlor”, to a person or institution (the “trustee”) for the benefit of some number of beneficiaries.

Property of any sort may be held in a trust. Trust benefits are usually created by a will, insurance policy, retirement plan, annuity, through the drafting of a trust instrument, or by other contract.

Trusts are often favored in estate planning because they do not go through the probate system, and are governed by the terms under which the trust was created. Further, trusts are also favored, for both personal and commercial reasons, because of how trusts provide benefits with various tax laws and help in the protection of assets.

What is a QTIP Trust?

One popular trust that is used to avoid various estate taxes is called a Qualified Terminable Interest Property Trust (“QTIP Trust”). As explained below, a QTIP trust will preserve the marital deduction for a surviving spouse, while also avoiding costly taxes often associated with the estate of the deceased.

A QTIP trust generally serves two main purposes:

  1. The QTIP trust allows you to attach conditions on your property, rather than simply leaving it to your spouse outright. This is especially useful if you’re on your second marriage and want to provide for both your current spouse and your children from a previous marriage after you pass away; and
  2. When one spouse dies, it lets the surviving spouse decide how much of the deceased spouse’s property should be held in trust to maximize estate tax savings, which is helpful for combatting the ever changing field of estate taxes.

Both of these purposes are elaborated further below.

What are the Benefits of Putting My IRA in a Trust?

Without the QTIP trust a deceased spouse’s Individual Retirement Account (IRA) funds would become immediately available to the surviving spouse. However, some persons may believe that the surviving spouse is not sophisticated enough to be capable of directly managing the account or there is a wish that the funds be available to the children after the surviving spouse has died, rather than solely to the surviving spouse.

As mentioned above, in cases where there were previous marriages and children born to those marriages, one may wish that their funds be used towards the benefit of both children of previous marriages and their current spouse.

How Can I Avoid Estate Taxes for My IRA Through QTIP Trusts?

Through the use of a QTIP trust, your IRA does not go to your surviving spouse right after the deceased’s death. Thus, both the IRA and the trust must meet the special qualifications of the Tax Code for the marital deduction for the estate tax. If the requirements are not met the IRS will become a taxable asset for estate tax purposes.

As can be seen, the easiest way to avoid the estate tax and to qualify for the estate tax marital deductions is by creating a Qualified Terminable Interest Property trust. In order to form a QTIP trust some basic requirements must be met, including that:

  1. The property of the trust must pass to the surviving spouse from the deceased spouse;
  2. The property, usually monetary in nature, must be distributed at least on an annual basis;
  3. There must be no power of appointment in the surviving spouse or others to benefit anyone except the surviving spouse, during the surviving spouse’s lifetime;
  4. The executor must elect on return; and
  5. The trust property will be included in the surviving spouse’s estate for federal tax purposes.

The last requirement is the most beneficial in nature, because it means that for federal tax purposes the property of the trust are considered part of the surviving spouse’s estate, and, thus, are not subject to the estate tax on the decedent spouse’s estate. This means the trust property assets will be protected from the federal gift and estate tax.

What is Considered Income for QTIP Distribution?

Income in the context of trusts means any income producing investments combined with the fixed percentage of the annual value of the principal assets. However, in 1997 Congress passed the Revised Uniform Principal and Income Act (UPIA) and the Prudent Investor Act, which many states have since adopted.

Included in the Acts, is the power to adjust receipts between the income and the principal. In turn, the IRS has modified its consideration of “income” to the benefit of the beneficiary when it comes to tax season. However, not all states have adopted the Acts, and despite the IRS’s attempts to clarify the rules, it is important to learn your  local state’s rules.

Should I Hire an Attorney If I Want to Create a QTIP Trust?

As can be seen, forming a trust as a QTIP trust is extremely beneficial and an excellent way to avoid costly estate and federal gift taxes, the laws are ever changing, vary by state, and are extremely confusing.

Thus, it may be in your best interest to consult and hire a qualified and experienced estate attorney near you, to ensure your QTIP trust is formed properly. Missed deadlines or improper formation of a QTIP trust can cost the trust thousands of dollars or lose the marital deduction for your estate.