Estate planning for blended families and for those without children can raise difficult issues, but viable options normally exist to keep the parties satisfied.
Blended family situation: Married couple where one or both spouses have children from a prior relationship. They would both like to ensure that their spouse is well taken care of financially at their death, but also want to ensure that their children receive all or a portion of their remaining wealth at the second spouse’s death.
Married couple without children situation: Like blended families, the spouses would like to ensure that their spouse is well taken care of financially at their death, but also want to ensure that their desired family members, friends or charitable beneficiaries receive all or a portion of their remaining wealth at the second spouse’s death. This is the identical issue as with blended families, but the emotional need to ensure that a significant portion of the wealth eventually benefits desired family members, friends or charitable organizations at the surviving spouse’s death is normally not as strong as the need to benefit children by a prior relationship.
Question 1 of the big three estate planning questions for married couples is the focus of this Newsletter. As discussed in prior Newsletters, a married couple must answer three (3) big picture questions in order to properly structure their estate plans. Question 1: To whom and how are the assets to pass at the first spouse’s death? Question 2: To whom and how are the remaining assets to pass at the second (surviving) spouse’s death? Question 3: What is the primary estate planning document to be used to set out the answers to questions 1 & 2, which can be either a Will or a Revocable Living Trust (in conjunction with a pour-over Will)? The focus of this Newsletter is Question 1, which can raise difficult issues and related conversations for blended families and for couples without children.
The realization that starts the potentially difficult conversation. Essentially, you lose any future control over any assets you pass to your spouse outright after your death. As a result, the first spouse to die loses any ability to ensure that their desired beneficiaries will benefit at the second spouse’s death to the extent assets are passed to the surviving spouse outright. This can sometimes feel like a gut punch because the spouses are torn between their desire to ensure the financial well-being of the surviving spouse and their desire to, at least eventually, benefit their children or other desired beneficiaries. The good news is that viable options exist for most of our clients to deal with this issue.
The viable options to benefit both the surviving spouse and help ensure that your children or other desired beneficiaries benefit from your wealth:
Option 1: Trust each other to do the right thing.
Under Option 1, all the assets are passed to the surviving spouse outright (unless Option 3 is also used to pass these assets to the spouse in trust).
This is the simplest option, and it is generally used when: (i) the spouses have absolute trust in each other to do the right thing and thereby carry out their wishes after the first spouse’s death; or (ii) the spouses heavily favor ensuring the financial security of the surviving spouse, and they (a) do not believe sufficient assets exist to utilize the other available options, (b) they do not like the other available options, or (c) they simply do not care that much about what happens with any remaining assets after both of their deaths.
Option 2: Benefit all the desired beneficiaries at the first spouse’s death.
Under Option 2, the assets of the first-to-die spouse will be split up among the various desired beneficiaries at their death, which ensures that each one receives a sufficient portion of their wealth. Under this option, the assets intended for the surviving spouse are to pass outright (unless Option 3 is also used to pass these assets to the spouse in trust). With this option, the parties are at least assured of getting some assets to their children or other desired beneficiaries and the further hope is that the surviving spouse will provide even more at the second death. However, even if no more assets end up going to the first spouse’s children or other desired beneficiaries, the belief is that this is acceptable.
Under this option, the amount passing to the children (or other desired beneficiaries) could be a relatively small amount or it could be significant, and the remainder will then pass to the surviving spouse. Alternatively, the opposite could be done, whereby the spouse is given an amount (relatively small or significant) and the remainder is then passed on to the children (or other desired beneficiaries).
Option 3: To the extent assets are to be passed to the surviving spouse under Options 1 or 2, they are instead passed in trust rather than outright.
Under Option 3, passing assets to the surviving spouse in trust provides the first spouse to die with some level of retained control over such assets to help ensure that at least some assets pass to the prior relationship’s children (or other desired beneficiaries) at the surviving spouse’s death. When this option is chosen, the next big question is who will serve as the Trustee of the trust for the spouse’s benefit. If the spouse serves as Trustee, this will likely be more palatable to the spouse, but this also waters down the retained ability to control the trust’s assets. If a third party is to serve as Trustee, which could include a trusted individual or professional Trust Company, then the retained control is strengthened but this may not be as palatable to the spouses. The conversation often goes something like this. “Before one of you dies, the assets are available to both of you, but after one of you dies, the surviving spouse will need to deal with a third-party Trustee to access at least some of the assets.” At least one of the spouses may then balk at having to deal with a third party to access any part of their combined wealth.
Even if Option 3 is chosen, the following types of assets that are intended to pass to a surviving spouse will normally be passed outright rather than in trust.
- Primary residence (home) for income tax purposes. If the residence is owned by the spouse and it serves as the spouse’s primary residence, then up to $500,000 of gain is excluded upon sale if the spouse is considered married (which status exists for two years after their spouse died) or up to $250,000 of gain is excluded when the spouse is considered single (which status exists more than two years after the spouse’s death, unless the spouse remarries).
- Individual Retirement Accounts (IRAs) and Qualified Retirement Plans (QPs) for income tax purposes. The Required Minimum Distribution (RMD) rules are much more favorable when these accounts are passed to a spouse outright rather than in trust, which normally permits significantly more income tax deferral to the extent these assets are not needed for the surviving spouse’s immediate support.
- Most types of tangible personal property, because it normally does not make sense to have these type assets owned in trust.
A big caveat to Option 3.
While passing assets in trust to the surviving spouse can be a beneficial strategy in coming up with an estate planning structure both spouses can live with, the parties need to understand its negatives. First, this type of structure is more complicated and costly to administer. Second, a higher risk exists that the surviving spouse could have conflicts with the remainder beneficiaries who are to benefit at the surviving spouse’s death, including the children by a prior relationship or other desired beneficiaries. The clear reality is that the actions of the Trustee (which could be the spouse, if desired) as to investment decisions and as to benefiting the surviving spouse will affect the remainder beneficiaries, and this can lead to stress among the parties. Of course, the downsides of Option 3 may be well worth the extra assurance that the prior relationship’s children or other desired beneficiaries benefit at the surviving spouse’s death.
Additional considerations in deciding on the best option.
- Get assistance from a financial professional.
A common concern is that inadequate wealth exists to ensure both the surviving spouse’s financial security and that enough wealth passes to the children by a prior relationship or other desired beneficiaries. In order to combat this concern, the first step is to determine how much wealth is needed to ensure that the surviving spouse will be financially secure. After this information is learned, better decisions can often be made.
- Consider purchasing additional life insurance.
If it is determined that insufficient wealth exists to satisfy all your beneficiary desires, then the purchase of life insurance can be an excellent option to create the needed additional wealth. Of course, the viability of this option will depend on the insurability of the spouses. If the spouses are not too old and are relatively healthy, the cost of insurance can be an acceptable means of resolving this important family issue. However, if the spouses are elderly and/or relatively unhealthy, the cost of life insurance may be prohibitively expensive.
If you would like to discuss which may be the best option in passing assets to your loved ones in your particular situation or other aspects of your estate plan, please call us at (678) 720-0750 or e-mail us at info@morgandisalvo.com to schedule a consultation. We look forward to meeting you.
