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 more 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 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 principle. 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 taxes.
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 might 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.
