Types, features, and taxation of trusts

Revocable and irrevocable trusts, bypass and marital trusts, QTIP, ILIT, GRAT, QPRT, charitable remainder and lead trusts, dynasty and special needs trusts: their purpose, key features, and gift, estate and income tax treatment. Items match a trust to a planning objective.

QTIP trustGrantor retained annuity trustInternal Revenue Code Section 2702

Practice question for this objective

Free sampleEstate Planninghard

Margaret, aged 74 and in ordinary health for her age, transfers 5,000,000 dollars of closely held company stock into a ten year grantor retained annuity trust. The annuity she retains is set so that the actuarial value of the remainder is close to zero, and her three children are the remainder beneficiaries. The stock grows strongly and the trust is worth 8,600,000 dollars when Margaret dies in the sixth year of the term, with four annuity payments still to run. Her planner is asked what the death inside the term does to the plan. Which assessment is correct?

ANothing is drawn back, because funding the trust was a completed gift of the remainder and her retained annuity simply ended at death
BOnly the actuarial value of the remainder interest, measured at the date the trust was funded, is drawn back into her gross estate
CSubstantially the whole trust is drawn back into her gross estate, leaving the family close to where it began apart from the set-up costs Correct
DHalf of the trust is drawn back, because she survived six years of the ten year term and the inclusion is prorated across the term

A grantor retained annuity trust fails if the grantor dies inside the term, because the retained annuity draws the trust assets back into the gross estate. The technique works by splitting the asset into a retained annuity and a remainder. The remainder is valued at funding using the assumed interest rate, and if the annuity is set to absorb almost the whole present value the taxable gift is close to zero, which is why the technique is cheap to attempt. That structure carries mortality risk. When the grantor dies while still entitled to the annuity, the amount of trust corpus needed to produce that annuity stream is included in the gross estate, and where the annuity was set to zero out the gift that measure sweeps in substantially all of the fund, here nearly the whole 8,600,000 dollars. The important planning point is asymmetric: because a zeroed-out trust uses almost none of the lifetime exemption, the downside of dying inside the term is the loss of the professional fees and the opportunity, not the loss of exemption. That asymmetry is why short terms and rolling trusts are used for an older or less healthy grantor, and it is a different risk profile from a qualified personal residence trust, where dying inside the term likewise pulls the residence back but the grantor has already spent exemption on the reported remainder gift.

Why A is wrong: This is tempting because a remainder gift was indeed reported when the trust was funded, but a retained annuity is an interest kept by the transferor, and property subject to a retained income style interest at death is brought back into the gross estate.

Why B is wrong: This confuses the gift tax measure with the estate tax measure; the value reported for gift tax purposes at funding has no bearing on the amount included at death, which is measured by reference to the corpus needed to fund the retained annuity.

Why C is correct: Because she died holding the retained annuity, the corpus required to produce that annuity is included in her gross estate, and for a near zeroed-out trust that measure absorbs almost the entire fund, so the appreciation is not moved out of the estate.

Why D is wrong: Prorating by elapsed term feels intuitive and matches how some candidates remember the rule, but the inclusion is not time apportioned; it is computed from the annuity the grantor still held, so surviving most of the term does not shelter a proportionate slice.

See more CFP practice questions, answers explained.

Exam traps in Estate Planning

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

The transfer was a completed gift of 4,000,000 dollars, so a gift tax return is due and the assets leave her taxable estate at their date of transfer value
Why it is wrong: This is tempting because the assets have changed hands in form and the children are named, but a gift is complete for transfer tax purposes when the donor gives up dominion and control, and a retained power to revoke means she has given up neither.
An outright bequest of the 800,000 dollars to Daniel, accompanied by a letter of wishes asking him to clear the two judgements first and to apply the balance to his housing, medical care and treatment
Why it is wrong: This is administratively simple and gives Daniel immediate access to money he genuinely needs for treatment, which makes it attractive, but a letter of wishes imposes no obligation and the whole fund becomes his property and is immediately exposed to both judgement creditors.

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