Qualified Plan QTIP Formula
The Qualified Plan QTIP Formula (Trust) is a recommended partitioning formula for any married client(s) having significant funds in a qualified retirement plan – of one or both spouses - such as an IRA, 401(k), pension plan etc. An A/B formula is that which creates the partitioning of a Marital A/B Trust into Trust “A’ and Trust “B” at the first spouse’s decease. The most easily understood A/B formula is the pecuniary credit shelter formula.
Our offices have used the pecuniary credit shelter formula for A/B Trust planning for almost as long as the unlimited marital deduction allowance became law through the federal 1981 ERTA legislation. However, pecuniary credit shelter formula clauses may cause unwanted tax liabilities if the trust estate of the first spouse to die possesses a significant portion of the total value of his estate in qualified plan funds and is funded to the credit shelter trust upon his decease.
The Qualified Plan QTIP Formula essentially funds the QTIP Trust in reverse of the method normally used with the pecuniary credit shelter formula; that is, it (the QTIP) is funded with the maximum amount of assets (qualified plan assets first) so as to cause a minimum of transfer tax liability of the decedent’s estate by the use of the unified credit. This “reverse funding” method allows the trustee to fund the QTIP Trust with qualified plan assets. The formula and accompanying language will eventually spin off the greater of (i) all distributable net income or (ii) the amounts required under the minimum distribution rules - to the surviving spouse.
In all events, it is a requirement for taxpayers that all net income from the QTIP Trust be distributed to the surviving spouse on an annual or more frequent basis for it to qualify as a marital deduction trust under the rules of IRC section 2056(b)(7). Funding the QTIP Trust then, rather than the Credit Shelter Trust, with qualified plan assets may help avoid certain taxation pitfalls that would otherwise apply to certain minimum distribution rules instigated by qualified plan asset transfers to a Credit Shelter Trust.
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