Journal of Financial Planning: February 2014
Philip Herzberg, CFP®, CTFA, AEP®, is president-elect of FPA of Florida, chair of FPA of Miami, and a member of the Estate Planning Council of Greater Miami Board of Directors.
A blended family brings together children, assets, and frequently, different family values and cultures. In essence, estate planning for blended families is difficult. The unique interests of a new spouse and children often create conflict with a parent’s aspirations to provide fairly for children from a previous relationship, resulting in unforseen challenges, misunderstandings, and irreparable damage to the blended family unit.
As a planner, what steps can you take for such couples to help preserve family harmony? Assess the following estate planning considerations for blended families within the context of the needs of the surviving spouse and the desire to leave a legacy to the deceased spouse’s natural children.
Blended Family Challenges
Obtain knowledge of the blended family’s distinct needs by using a comprehensive estate planning checklist, supplemented by in-depth interviews early in the process. Determine priorities and wishes to optimally facilitate your planning.
Would partners be satisfied with the respective state law protecting their assets before remarriage and splitting their marital property in the event of another divorce? Think about using a prenuptial or postnuptial agreement to keep assets separate and to delineate support obligations to a prior spouse or children.
Concurrent with the direction of legal counsel, you should review and apply state laws to devise a marital agreement that appropriately addresses blended family issues and achieves your parties’ intended dispositive goals. Educate prospective spouses on the relevant state provisions, so they can protect the inheritance rights of sizable assets, such as a vacation home or business, for their children.
Attend to how the estate will pay any taxes and the manner in which multiple sets of family beneficiaries and different types of assets will share the tax burden. If the estate planning documents do not sensibly cover this issue, you may have one set of beneficiaries paying the estate tax on another set’s larger inheritance. Regretfully, this disparity may not be discovered until after the second spouse’s death when planning options are much more limited.
Most importantly, inform couples who remarry or have additional children to update beneficiary designations on retirement accounts and insurance policies. Be cognizant that beneficiary designations trump wills or trusts if the documentation supporting the policies and accounts is inconsistent. Ascertain that spouses in second or later marriages articulate any revisions affecting family members and other loved ones when updating living wills, durable powers of attorney, and health care directives for medical decisions. Carefully review the titling of each asset to ensure effective protection and smooth transition after the death of a family member.
Note that designating spouses as beneficiaries of life insurance and tax-deferred plans can be a dilemma with second marriages, because a spouse-beneficiary can subsequently appoint anyone he or she wants as new beneficiaries to inherit the proceeds, bypassing blended family children. Consider naming a trust as beneficiary for these policies and plans to viably safeguard how and to whom the proceeds are distributed in a second marriage. Be wary that selecting a surviving spouse as primary retirement plan beneficiary involves a tradeoff between the best possible income tax result and assurance that the participant’s children will inherit the retirement plan proceeds.
Actionable Family Estate Planning Strategies
Are there memorable family heirlooms, like antiques and jewelry, that remarrying couples would like their natural children to have upon their passing? Avoid a possible contestable situation and formulate the suitable family blended estate plan for these personal assets.
Be sure to engage appropriate legal counsel before you pursue any financial or legal strategy to assist blended families. Guide remarrying couples in identifying an unrelated trustee, a fiduciary who has intimate knowledge of the blended family’s dynamics and is flexible to the evolving needs of the trusts. Evaluate having a capable professional trustee serve as a co-trustee to create a check and balance decision-making system for larger estates and trusts with stepchildren.
For example, you can help create a long-term discretionary trust (LTD trust) and select a professional trustee to administer the inheritance for blended family children. Prudently manage investment and interpersonal trust intentions by applying spendthrift provisions for these blended family children and protecting them from ill-conceived financial decisions.
Weigh the benefits of devising a bloodline trust to maintain optimal control for each child in the blended family unit and to preserve funds in his or her bloodline. In the event of a child’s future divorce, lawsuits, and bankruptcies, you can strategize for the bloodline trust to protect his or her inheritance from potential creditors and claimants.
The irrevocable life insurance trust (ILIT) is another estate planning technique designed to protect a specific inheritance amount to blended family children, whether the proceeds of the policy remain in trust or are distributed outright when the insured passes away. Using life insurance to fund the inheritance may prevent the remarried partner from having to dip into the expected pools of assets available for the other spouse’s natural children or the children from the current relationship. Further, you can employ an ILIT to provide the liquidity a family may need to cover taxes on an estate consisting of relatively large illiquid assets, such as real estate or closely held businesses. Consult with qualified estate and tax planning professionals to discuss any potential gift-tax implications related to funding the support of payment of life insurance premiums.
Think about structuring a family limited partnership (FLP) or limited liability company (LLC) comprised of family members to transfer specific assets, such as real estate, to children and their bloodline descendents. Shield the couples’ blended assets from the claims of their previous spouses, as well as their children’s spouses, former spouses, and possible creditors.
Disentangling Age and Wealth Disparities
Vast age differences between remarried spouses can present planning problems, including the application of special rules for computing the retirement plan required minimum distributions when the participant is more than 10 years older than the new spouse. If the younger spouse is close in age to the elder spouse’s biological children, the kids may not wish to wait for the younger spouse to die before receiving most of their inheritance. Tackle this blended family issue by using a qualified terminable interest property (QTIP) trust to provide regular income for a spouse while preserving principal for the children of a prior marriage. Alternatively, you can plan with a unitrust to give the surviving spouse a set percentage of the trust’s assets, rather than only the investment income.
Similarly, wealth disparities in remarried spouses can create complicated estate planning issues in blended families. Recently portability has made planning for these partners easier by enabling the second-to-die spouse to combine his or her unified credit with the first-to-die spouse’s remaining credit. Bear in mind that spouses are prohibited from accumulating exemptions ($5.34 million in 2014) through remarriages and can use the remaining exemption of their most recent spouse.
How can you plan for differences in residential assets between second spouses? Consider giving a non-owning surviving spouse the right to live in a life estate, while ensuring that the residence passes to the owner’s natural children upon the individual owner spouse’s death. Know that the home will revert to the owner’s adult children or other designated beneficiaries upon the survivor’s subsequent death.
Realize also that a surviving spouse, sans an estate plan, may not have sufficient financial resources to continue to live comfortably when a deceased partner leaves the majority of the family assets to his or her natural children. To remedy the monetary and emotional burden caused by this situation, states enable a surviving spouse to claim an elective share amount of the deceased spouse’s estate paid from the assets left to the children. To prevent potential blended family difficulties, you can have each remarrying spouse sign a marital agreement detailing how assets will be distributed in accordance to their wishes.
Fully acquaint yourself with the issues and concerns common to blended families to optimally provide for each spouse and protect the interests of their respective children. Prepare and implement a successful estate plan to fulfill the diverse needs and aspirations of blended family members.