There’s more to estate planning than death taxes.
As important as it may be, preparing for estate and inheritance tax liabilities is just one component of a sound estate plan. Estate planners like to say that because every family is unique, there are no “cookie-cutter,” one-size-fits-all solutions. The truth of that axiom is best demonstrated by looking at the unusual problems that can be presented by “blended families,” those resulting from multiple marriages. High divorce rates are one source of the phenomenon, but so is growing life expectancy.
The following fictitious stories illustrate some of the estate planning problems that may crop up in these situations.
The lost inheritance.Ann had been widowed for five years when she married Jack, a divorced man with two adult children from his first marriage. Ann had three grown children of her own. She was left in very good financial shape at her husband’s death, and she had done a good job of managing her money on her own. Ann’s big mistake was that she agreed that she and Jack should leave all their assets to each other. Ann was certain that she would outlive Jack anyway, as he was older and in poor health. When Ann died unexpectedly, Jack inherited everything from her. Ann’s children aren’t likely to get any inheritance from their parents, as Jack has big plans for taking care of his own children.
An unexpected return. Tom and Sara lived the “Yours, Mine and Ours” story. They each brought a child to their marriage, and then they added two more. They succeeded in keeping friction among the stepsiblings to normal levels and appeared to be heading toward “happily ever after.”
But when Tom died, an unexpected beneficiary appeared. It turned out that Tom never had changed the beneficiary designation on his 401(k) plan, so his first wife, Molly, inherited nearly $1 million. Sara and the couple’s children were shortchanged.
May-December marriage. Mark has remarried several times, but now he’s found the one with whom he plans to stay for the rest of his life. Megan is quite a bit younger than Mark. In fact, she’s younger than Mark’s children from his first marriage! Mark’s estate plan gave Megan a lifetime income interest in his assets. She had the right to live in their home and receive all the income from their investments. At her death, Megan did not have the power to direct these assets to others—Mark had seen to it that his children could not be disinherited. What Mark failed to anticipate was that Megan would live longer than any of his children, so none of them ever received any inheritance (but the grandchildren did, eventually).
The first tool to think about in a second marriage situation is a prenuptial or ante nuptial agreement, or “prenup” for short. Although these documents have their greatest utility in the context of divorce, because they spell out in advance what each spouse may expect, a prenup can be valuable for estate planning as well. The prenup will identify the assets that each partner brings to the marriage, and it may specify which assets will remain separate property. Provision may be made for the expected eventual distribution of the property. The process of inventorying assets lays a good foundation for subsequent estate planning.
Tom’s mistake was that he never “finished” the divorce from his first wife. Steps needed to be taken to change beneficiaries for every life insurance policy, every IRA and retirement plan. A thorough asset review in connection with creating a prenup, before Tom and Sara married, would have revealed any oversights.
Ann’s husband should have employed a Qualified Terminable Interest Property Trust (QTIP trust) to provide for widowhood, rather than leaving her their property outright. With a QTIP trust, the children’s inheritance normally can’t be diverted. The surviving spouse must receive all of the trust income, paid at least annually. The trustee also may be given the power to invade trust principal in specified circumstances. But at the widow’s death, the remaining trust assets pass as specified by the person who established the trust.
Mark did use a QTIP trust, but the problem was that he failed to take into account the likely survivorship of his young wife. Mark would have been well advised to purchase life insurance to create an inheritance for his children at his death. He could have employed an irrevocable life insurance trust to avoid estate taxes on the insurance, while the QTIP marital deduction would eliminate estate taxes on what Megan would receive.
The most flexible approach to preserving an inheritance for children, whether they are minors or adults, is a trust. The trustee can take subsequent circumstances into account in sprinkling the income distributions among the beneficiaries. An irrevocable trust also provides financial protection in divorce, bankruptcy and lawsuits. It can be a mechanism for supporting financial discipline and avoiding irresponsible spending and the waste of an inheritance.
Take the next step
Basic estate planning for blended families requires care and regular review. An estate planning attorney’s supervision will be required. We will be pleased to offer our counsel as well.
MINNESOTA RESIDENTS’ ESTATE TAX PENALTY!
While the federal estate tax exemption allows individuals to pass up to $5.25 million estate tax free ($10.5 mill. per couple), Minnesota residents can still only pass $1 million per individual (and per couple) estate tax free (without tax planning). This includes the full death benefit of your life insurance, cabin land, business assets – basically everything. Any assets over $1 mill. could be taxed as high as 30% without proper planning. Why not $2 mill. for a couple? Minnesota does not have “automatic portability” for spouses. See me to assist your family in avoiding the Estate Tax Penalty for Minnesota Residents.