Assets of a decedent that is a participant in a retirement plan can be left to a surviving spouse to obtain the benefits of the estate tax marital deduction, and thus avoid current estate taxes at the death of the decedent. While there are reasons for leaving such plan assets outside of trust, decedents at times want to tie up the assets in trust, and thus a transfer to a QTIP trust may be advisable.
Natalie Choate, a leading authority on the tax aspects of retirement plans, recently reviewed four basic requirements needed to avoid tax problems with funding retirement assets into a QTIP. The four basic requirements are:
1. The QTIP trust should be named as the beneficiary. An alternative is to name a funding trust as a beneficiary, which allows the use of funding formulas to assure that only an amount of plan assets needed to minimize estate taxes end up in the QTIP trust. However, use of such a funding trust involves other tax issues and complexities that can be avoided by naming the QTIP trust as the beneficiary. In the event that this results in "overfunding" the QTIP trust, this overfunding can be ameliorated by a partial QTIP election for the overfunded QTIP trust.
2. Provisions must be added to require that the surviving spouse receives all of the income of BOTH the QTIP trust and the plan interest that is funded into it.
3. Properly specify how the income that must be distributed is to be computed. Such method must produce income in a manner acceptable to the IRS. Note that one acceptable method is to require a unitrust payout of from 3% to 5% of the trust's value each year.
4. A proper QTIP election needs to be made on the estate tax return.
SOURCE: Leaving Retirement Benefits to a QTIP Trust by Natalie Choate, Estate Planning Journal (WG&L)