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Estate Planning For Blended Families

By: Investor Solutions

By: Investor Solutions, Inc.

With divorce rates as high as ever, more and more families today are becoming “blended” with children from different marriages. This can create an enormous challenge when it comes time to settle your estate and plan the distribution of your assets. Estate planning is essential for any family, but it’s even more important for the modern day “blended family”. If you don’t want to accidentally disinherit your kids from a previous marriage, read on. One of the best techniques to ensure that your assets are distributed correctly is by incorporating a QTIP Trust in your plan.

The best reason for using a QTIP trust is not necessarily for estate tax savings, but for asset control. Under normal circumstances, in order to qualify for the federal estate tax marital deduction, a spouse’s interest in a trust must not terminate. A QTIP (Qualified Terminable Interest Property) Trust is the exception to the rule.

Contributions to a properly structured QTIP trust qualify for the marital deduction, while allowing the donor to specify the ultimate disposition of the assets. The QTIP trust is established pursuant to the donor’s will but must ensure that specific conditions are met:

  • the surviving spouse has no power to distribute the principal/corpus but must have a lifetime, annual mandatory and exclusive right to trust income
  • the surviving spouse (or the surviving spouse’s estate) must be entitled to and is the sole beneficiary of all the annual income or use of property for life
  • trust income cannot be terminated by remarriage or other event

A QTIP Trust is commonly used in a second marriage situation when a spouse has children from the previous marriage and wants to ensure that assets will pass on to those children. Under most arrangements, the QTIP trust is structured so the surviving spouse receives the income from the trust and the principal is left to the children from the deceased spouse’s first marriage, as determined by the first spouse to die.

A Marital Trust, by contrast, is a trust whereby the grantor spouse transfers full control of the trust assets to the surviving spouse. These trusts are appropriate when the grantor spouse:

  • wants to leave assets in trust in lieu of an outright transfer
  • wants to take advantage of marital deduction
  • wishes to give surviving spouse total control over the assets
  • does not care who the surviving spouse leaves the money to

Many estate plans may include multiple trusts with different purposes and estate tax implications. For instance, combining a Marital Trust, QTIP Trust and Credit Shelter Trust (also known as Bypass Trust) is not uncommon. Suppose an individual wishes to transfer assets directly to the surviving spouse’s control, but also ensure that his/her children from a previous marriage receive a portion of the estate too. The Assets left in a marital trust give the spouse full discretion over trust assets, but the assets in the QTIP and even the Bypass trust may have specific provisions for other intended heirs.

Let’s explore the use of a QTIP trust in conjunction with a bypass trust and marital trust. Here, the marital assets flow into a combination of the marital trust and the QTIP trust, both of which qualify for the unlimited marital deduction. Then the Credit Shelter/Family trust is funded with enough assets to take advantage of annual exclusion of $1,500,000 (for 2004 and 2005).

The assets in the Marital trust bypass estate tax for the first spouse to die (because of the unlimited marital deduction), but is taxed in the estate of the 2nd to die. The surviving spouse, of course, has the ability to name his/her own heirs.

The QTIP trust, like the Marital trust, bypass estate tax for the first spouse to die (because of the unlimited marital deduction), but is taxed in the estate of the 2nd to die. The difference is that the remaining assets are then transferred to the remaindermen named by the transferring spouse.

The Credit Shelter trust escapes federal estate tax completely. This trust is most often used as a family trust (for the benefit of all family members) and may also be used for lifetime income for the surviving spouse. Federal estate tax is avoided in the first estate, and the property in the credit shelter trust escapes taxation in the survivor’s estate too.

In blended families, a QTIP trust may also introduce obstacles. For instance, if a client is not willing to agree on the remarriage contingency or the client is uncomfortable with distributing all the income to the surviving spouse, then a QTIP will clearly not work. As an alternative, the client may wish to purchase additional life insurance via an irrevocable trust.

Despite the various restrictions imposed by a QTIP trust, it does provide a great flexibility in federal estate tax planning, particularly for blended families. Setting up a trust for your spouse to use during his/her lifetime, qualifying for a marital deduction while then controlling the disposition of the principal to your intended heirs is a tremendous benefit and planning tool that should not be ignored. As always, it’s best to seek the advice of a qualified legal professional to execute the most appropriate strategy.