As it was famously sung about the Brady Bunch, you knew it was much more than a hunch and now your group must somehow form a family. Like the Brady Bunch, blended families consist of a couple and their children from previous relationships. Forming this blended family provides numerous benefits not the least of which is the abundant love found within. Protecting that love and harmony is of paramount importance when it comes to estate planning.
Couples often name each other as their primary beneficiary to their estate and then name their children as contingent beneficiaries. While this plan may seem harmless at first glance, it is fraught with potential dangers for blended families. The primary danger is your surviving spouse receives your entire estate upon your death and then, through purposeful or inadvertent actions, boxes out your children from your first relationship.
So, how does one safeguard against this undesirable result while still providing for their surviving spouse? The answer can be found by incorporating a qualified terminable interest property (QTIP) trust.
QTIP Trust Basics
In a QTIP trust, the creator of the trust gives a life estate interest (not a legal ownership interest) in the trust’s assets to their surviving spouse, which allows for the principal and income to be used for the benefit of the surviving spouse. However, the QTIP trust does not give full control or legal ownership of the assets to the surviving spouse. A “life estate interest” is simply a “right to use” under a preset perimeter of rules.
In a QTIP, a trustee (chosen by the trust’s creator, who could be another family member, friend, or third-party professional) manages the trust assets for the benefit of the surviving spouse until the surviving spouse’s death. Upon the death of the surviving spouse, the remaining balance of the trust is either distributed or managed for the chosen beneficiaries set by the trust’s creator. These predetermined contingent beneficiaries could include your children from a prior relationship or a combination of your children and your spouse’s children from a previous relationship. The QTIP trust is irrevocable upon the death of its creator, meaning no one, including the surviving spouse, can amend or change the trust or its beneficiaries.
In management of the assets, certain rules and standards can be set for the distribution of income and principal to the surviving spouse during their lifetime. Often such rules and standards limit the distributions for the surviving spouse’s health, education, maintenance, and support, but only after considering the other resources available to the surviving spouse, at the discretion of the trustee. These rules and standards ensure the care of the surviving spouse while maximizing the likelihood that there will be a remaining balance for the trust creator’s children from a previous relationship or other chosen beneficiaries.
Tax Considerations
Married U.S. citizens enjoy shelter from estate taxes through the unlimited marital deduction. This results in couples being able to give to one another at death without incurring an estate tax liability. Generally, to qualify for the marital deduction, an asset must be fully gifted to a spouse at death. However, the QTIP is an exception from the general rule. If properly drafted, a QTIP trust allows for the surviving spouse to benefit during their lifetime while qualifying such distributions under the marital deduction.
Distributions made after your surviving spouse has died will be subject to federal gift and estate tax, current exemption amounts to those taxes will likely shelter most estates from liability. QTIP trusts also provide flexibility in the event of a changing tax landscape, so that your executor can choose whether to take a QTIP election on a federal estate tax return.
Benefits of the QTIP Trust
By incorporating a QTIP trust into your estate plan, you can preserve peace of mind and family harmony. Peace of mind comes from knowing that your plan benefits both your spouse and your children from a prior relationship, and that it cannot be changed after your death. This provides assurance that your spouse will be provided for, and your ultimate beneficiaries cannot be purposefully or accidentally disinherited.
Family harmony comes by avoiding situations that create conflict between children from different sides of a blended family or between children and your surviving spouse. By ensuring your surviving spouse cannot alter your estate plan after your death and providing for both your spouse and your children, you eliminate potential sources of conflict and promote family harmony long after your passing.
For questions regarding blended families and QTIP trusts, contact estate planning attorney Tim Wilson at TSW@kjk.com or Christine Sabio Socrates at CSS@kjk.com.