The Benefits of a Q-Tip Trust

Depending on your situation, it may make sense to include the odd-sounding "Q-tip trust" in your estate plan. The name derives from a special estate tax break for "qualified terminable interest property."

An Extra Source of Protection for Your Children Q-Tip trusts are often used by blendedfamilies where the spouses each have their own children. The first spouse to pass away can use a Q-Tip to preserve the interests of his or her children or other intended beneficiaries. Presumably, without legal protection a surviving spouse could create a will that ignores the children of the deceased spouse, instead diverting all the assets to his or her own children. Including a Q-Tip trust in your estate plan allows you to provide your surviving spouse with a lifetime income interest in the assets in the trust, while ensuring that there is a legal framework in place for your children to receive their share of your assets after both you and your spouse have passed on.

To understand the benefits of a Q-Tip trust, you must first learn some basic estate tax concepts. Under the unlimited marital deduction, any property that is transferred from one spouse to another is completely free of estate and gift tax. In other words, if you leave property to your spouse when you pass away, there's no estate or gift tax liability.

However, the unlimited marital deduction generally is not allowed for property that passes to a spouse for his or her life and then to someone other than the surviving spouse. That could cause a potential estate tax problem for affluent families.

Fortunately, there is an exception for a "qualified terminable interest property" transferred to a trust. If a special election is made, the value of the property may qualify for the marital deduction. The property generally is included in the taxable estate of the surviving spouse.

In the case of a joint and survivor annuity, no amount is included in the donee's estate if he or she dies before the donor.

The election for a Q-Tip is made by the executor of the estate of the first spouse to die. Once the election is made, it is irrevocable.

Note: In some cases, it may actually be beneficial to forgo the Q‑Tip election. That's because the surviving spouse could end up with an unusually large estate. So the overall estate tax bill to the children may be greater than it would have been without the Q‑Tip election. Thus, it helps to designate an executor who is qualified to make these complex decisions.

Consult with your attorney about whether this trust would be beneficial in your situation.