Estate Planning for Blended Families
Many people don’t get serious about estate planning until they are well into middle age. By then, some of them are part of blended families: they are married, and one or both spouses have children from previous families. Estate planning in such families can be tricky because the spouses may want to provide both for each other and their own children. If you’re in such a situation, you should proceed cautiously.
Rethinking retirement plans
In a blended family, one or both spouses may have a sizable retirement account such as an IRA. One practice is to name the other spouse as primary beneficiary of the IRA, with the account owner’s children as the secondary beneficiaries. This approach is common in first marriages, in which the children are the offspring of both spouses, but it can lead to trouble in a blended family.
Example 1: David Jennings has $500,000 in his IRA. He names his wife Christine as the primary beneficiary and his two children from a prior marriage as the secondary beneficiaries. Thus, if Christine predeceases the children, they will inherit the IRA. Even if Christine does inherit the account, the balance will pass to David’s children at Christine’s death.
There are two flaws in this strategy. First, Christine can tap the IRA at will as long as she takes required minimum distributions. She can take out all $500,000 at once, pay the income tax and then either spend the money or give it to, among others, her own children from her previous marriage.
Second, in this example Christine is a surviving spouse and sole beneficiary of David’s IRA. Under the tax code, Christine can roll over David’s IRA to her own new or existing IRA. (No other beneficiaries can do this.) Then Christine can name any beneficiaries she wishes, such as her own children.
In either scenario, there is no guarantee that David’s children will see a penny of his $500,000 IRA.
How can David avoid this outcome if he wants to provide for Christine and his own children? One tactic is to divide his $500,000 IRA into two $250,000 IRAs. He can designate Christine as the beneficiary of one IRA; his children can be co-beneficiaries of the second IRA. Alternatively, David can leave the entire $500,000 IRA to his children, who can stretch out required minimum distributions over their longer life expectancy and thus enjoy extended tax deferral. If David adopts this plan, he can leave other assets to Christine, depending on the size of his estate and her financial needs.
Trust traps
In blended families, spouses also may use trusts in their estate planning. The first spouse to die might leave assets in trust for the surviving spouse, who will get the trust income and also might have some access to the trust principal. At the surviving spouse’s death, remaining trust assets may pass to the children of the spouse who funded the trust. Some trusts of this nature can be qualified terminable interest property (QTIP) trusts and defer estate tax.
Trusts can play a valuable role in estate planning. Again, though, trusts can cause problems in blended families. With the arrangement described previously, the trustee might face a conflict between investing for current income (which would benefit the surviving spouse) and investing for long-term growth (which would benefit the trust creator’s children). In addition, the children may have to wait for many years before receiving any inheritance if the first spouse to die leaves all of his or her assets to such a trust.
Dividing the estate might be a better solution. Some assets could be left to the surviving spouse and some to the children, outright or in separate trusts. If the spouses fear that such a plan would leave insufficient amounts to the beneficiaries, they might buy life insurance and increase the total estate value.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.