Special Purpose Trusts – 2 Most Common Forms

A trust is a legal entity that is created and holds title to assets during the life of the person who places assets inside the trust. The use of a special trust may be desirable to meet the unique challenges presented by a blended-family situation (where the family structure has changed because of divorce, separation or remarriage), or to avoid payment of estate taxes. Here, we examine two common forms of special trusts.

Qualified Terminable Interest Property (QTIP) Trust

The QTIP trust is often used when one spouse has remarried. It is a special trust that lets the maker of the trust, called the settlor, use the unlimited mar­riage deduction, provide for his spouse after his death, and defer potential estate taxes until the sec­ond death while retaining ultimate control over the distribution of his property. In using a QTIP trust, a certain portion of the settlor’s assets is transferred upon death into a trust that pays income (and potentially principal) to the settlor’s spouse for her lifetime. At the spouse’s death, the principal passes to the beneficiaries that the settlor has designated.

Irrevocable Life Insurance Trust (ILIT)

The ILIT trust allows an insurance policy to be held in a trust so that it will not be included in the settlor’s taxable estate. In order for the settlor to receive full tax advantages offered by an ILIT, he cannot name himself or his spouse as the trustee. After January 1, 2009, an individual can contribute $13,000 annually ($26,000 per married couple) per beneficiary to pay the premiums on the life insurance policy held in the trust. Upon the death of the settlor, or the settlor and spouse, the life insur­ance policy’s proceeds are paid to the trust. The trustee then distributes that money to the beneficia­ries as outlined by the terms of the trust.

The use of any trust for estate planning purposes ulti­mately will depend on a variety of factors, including the size and complexity of the estate, the need to avoid taxes, and the settlor’s desire to distribute assets outright or in trust. As shown above, the use of a special trust may help further the settlor’s specific goals and objectives.