Estate Planning for Second Marriages and Blended Families

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Estate planning can be difficult enough when planning for a wife and children, but when divorce and remarriage create a family where one or more spouses already have children, estate planning can go from difficult to confusing.  However, by using a qualified terminable interest property (QTIP) trust, this difficult task becomes easier.

QTIP Basics

According to Investopedia.com, a QTIP trust enables the grantor to provide for a surviving spouse, while still maintaining control of how the assets are distributed upon the death of both spouses.   

With many nuclear families from the 50s now blended families of the 21st century, a QTIP trust is a perfect solution to an often complex problem.  In a QTIP trust:

  • Once the first spouse passes away, the assets past to a trust for the surviving spouse
  • No other people or entities can receive any distributions from this trust
  • After the death of the surviving spouse, if there are any assets left in the trust, they are left to those named by the first spouse

For example, a man and woman who both have children from a previous marriage get married.  A QTIP trust is created by the man who later passes away.  His widow then receives money from the QTIP trust until her death.  Then, per the mans directive, his children receive the rest of the assets left in the trust.

Creating a QTIP Trust

One strategy in estate planning using a QTIP trust is referred to as an “AB Trust.”  After the death of the first spouse, the “B Trust” holds an amount up to the federal estate tax exemption.  In 2017, this amount is $5.49 million.  The “A Trust” then holds the excess amount over $5.49 million.  By using this strategy, the “A Trust” is indeed a QTIP trust and the trust will not have to pay estate or gift taxes until the surviving spouse passes away.

For example, Fred and Ethel both had a previous marriage.  Both of them also had children.  Fred is worth $1 million and Ethel is worth $10 million. With the AB Trust strategy, if Ethel dies first, the B Trust receives its funds of $5.49 million and the remaining $4.51 million goes to the A Trust.  No estate taxes will be due since the B Trust uses the federal estate tax exemption while the A Trust qualifies for the unlimited marital deduction.  Then, when Fred dies, both trusts can be written to include what is left passes onto Ethel’s children (or Lucy, or whomever else Ethel chooses.)  This particular type of trust is not actually created until after the death of the first spouse.

This may seem unfair to Fred’s children who are basically left out.  But, if Ethel had created and funded a Lifetime QTIP Trust before her death, she could have left Fred with tax-free gifts while she was still living.

Some QTIP Tips

When created during life or after death, QTIP Trusts must meet certain requirement to be eligible for the unlimited marital deduction.  These include:

  • The trust must be unalterable and irrevocable
  • The spouse must be a U.S. citizen
  • The surviving spouse must be eligible and entitled to receive all of the net income from the trust
  • The spouse must be able to convert non-income producing property into income-producing property
  • The spouse must be the only one with complete power to appoint trust property
  • If the QTIP Trust is a Lifetime QTIP Trust, Form 709 (the federal gift tax return) must be filed in a timely manner.
  • Although permitted, the surviving spouse will not need to have a right of distributions of principal from the trust
  • With a Lifetime QTIP Trust, if the spouse that is the beneficiary of the trust dies first, then the spouse that is granting the assets can, in fact, become the principal beneficiary of the assets excluded from their estate.

Although complicated at first glance, these requirements are relatively flexible and work well in many different situations.

The Benefits of a Lifetime QTIP

When a couple marries and one spouse has a substantially larger estate than the other spouse, a Lifetime QTIP Trust can offer many different benefits to the couple, such as:

  • Without the use of any gift tax exemptions, a wealthy spouse can create a Lifetime QTIP.
  • The Lifetime QTIP Trust can use the generation-skipping tax exemption for the spouse that is not as wealthy.
  • During the lifetime of the spouse who is receiving income from the trust, he or she may be entitled to receive principal monies for a limited number of reasons.
  • Upon the death of the wealthier spouse, the assets that are left in the Lifetime QTIP Trust will be included in the estate.  This is beneficial due to the surviving spouse’s ability to use the federal tax exemption.
  • If the spouse that is initially to receive the assets from the Lifetime QTIP Trust dies first, the surviving spouse can keep the trust in an asset-protected, lifetime trust with the remainder being excluded from the estate when the grantor spouse dies.
  • Once both spouses die, the beneficiaries that are chosen by the grantor spouse will receive the balance of the trust.

The Lifetime QTIP Trust is not a “one stop shopping” trust for everyone.  Each trust must be worded to show each unique family dynamic and economic situation.  Also, not all attorneys are created equal when developing a QTIP Trust.

Candidates for a Lifetime QTIP Trust

Those who have a second marriage with an unequal division of assets when entering the marriage are good candidates for a Lifetime QTIP Trust.  If a potential spouse is unsure whether or not a QTIP Trust is for them, contacting a CPA with experience in drafting QTIP Trusts is advisable.   

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