Estate Planning Options for Blended Families

The dynamics of a blended family, defined as one where at least one spouse has at least one child from a prior marriage or relationship, can complicate financial and estate planning because no off-the-shelf plans apply.

It's important to contact your estate planning attorney to ensure complete review of all personal and economic aspects of your family and a resulting plan that works for everyone involved. 

From designing account beneficiaries to updating Wills and Trusts, it takes attention to detail to ensure specific wishes are carried out properly. Effective, collaborative planning can address the family's needs and goals while building trust and helping everyone move forward together.

A good place to start is with reviewing and updating beneficiary designations for life-insurance policies and retirement accounts. That's a simple way to ensure that the proper beneficiaries are noted on all accounts and the proceeds from those accounts end up going to the correct individuals.

While any estate planning must be done on a case-by-case basis, the following are options to consider for blended families:

Reciprocal Wills

Some blended families use reciprocal Wills, where the assets pass outright to the surviving spouse, as their primary estate plan. They do this for the sake of simplicity and to keep their estate planning costs at a minimum. 

But this type of plan comes with some serious disadvantages. One issue is that it does not provide a great deal of comfort when there are children from a prior marriage, because the first spouse to die has no guarantee that the surviving spouse will provide for his or her children when the surviving spouse ultimately dies.

There are several ways the surviving spouse can defeat the intent of the deceased spouse even without changing his o her Will, including making gifts of assets during his or her lifetime, changing beneficiary designations, and re-titling assets as joint with a right of survivorship with his or her own children or even a new spouse, potentially leaving nothing to pass under his or her reciprocal Will.

Another major disadvantage of a reciprocal Will is that it is revocable. That means the surviving spouse can change it to favor his or her own children charities, or a new spouse. The surviving spouse also could deplete the estate by overspending and incurring debt, leaving nothing for the children of the deceased spouse. 

Non-reciprocal Wills

An option that does not require reliance on and trust in the surviving spouse is to have each spouse create a non-reciprocal Will, or Wills that are not exactly the same and don't leave the estate outright to the surviving spouse. Under this approach, each spouse could leave a percentage or dollar amount to the surviving spouse and a percentage or dollar amount to be divided equally between his or her own children, but not the children of the other spouse. 

It can be difficult to determine at the time the Will is made the amount needed to provide for the spouse and an appropriate amount to go to the children, so this type of estate plan requires monitoring and updating over time.

Life Insurance

A third alternative is to purchase life insurance to provide for the surviving spouse or the children of the first spouse to die. The advantage with using life insurance is that it guarantees, as long as the policy is active, that the children will receive something upon the death of their parent. Life insurance policies tend to become increasingly expensive as you grow older, however.

Life insurance provided by an employer can be used, but there are limits to the amount an employer provides. Also, coverage usually terminates when employment ends and may become unavailable if an employer files for bankruptcy. Therefore, relying solely upon employer-provided life insurance may not be the best alternative.

Testamentary Trusts

Creating a testamentary trust that becomes irrevocable upon the death of the first spouse meets the dual goals of providing for the surviving spouse during his or her remaining lifetime and then, upon the death of the surviving spouse, passing the remaining assets to the children of the first spouse to die.

Under this approach, a trustee will have to be appointed. Common options include the surviving spouse, a child of the first spouse to die, a third-party or a trust company. Appointing the surviving spouse or a child of the deceased spouse has a greater risk of creating family friction, and therefore a third-party or a trust company might be more appropriate.

Whichever option you choose, any estate plan should remain dynamic and adapt to change when necessary, particularly given the added complexities of a blended family.

Moving an Elderly Relative Could Trigger a Tax Problem

It's a common scenario: An elderly relative is no longer able to live alone, so family members sell the relative's house and have the relative start living with them or in a nursing home or assisted living facility that's closer to the family. 

One thing you might not consider during this stressful process is that if the relative moves to a different state, you might have just changed the person's official state of residence for tax purposes. And that could have a significant effect on his or her estate plan.

For instance, if someone moves from a state with no state estate tax to a state with such a tax, and he or she passes away, an estate tax might be owed on the value of the person's assets - even if he or she lived in the new state for only a very short time.

This is a significant danger because, while the federal estate tax generally doesn't apply to estates unless they're worth over $5 million, many state estate taxes start at a much lower figure. In Massachusetts, for example, the state estate tax threshold is only $1 million. 

Such an outcome could even lead to friction between heirs. For instance, suppose the relative's will leaves one child certain specific assets and the other child "everything else." The relative may have set things up so the children would receive more or less equal bequests. But under the law, if a state estate tax is suddenly due, all of it will come from the share of the child who gets "everything else." This could upset a careful estate plan and create family disharmony.

If you're thinking of moving an elderly relative to an out-of-state home or facility, it's a good idea to speak with an estate planner about the change. There might be ways to avoid having the relative be treated as a resident of the new state.

Of course, you might also discover that there are tax advantages to having the relative be treated as a resident of the new state, and you'll want to plan for that as well.

Estate Planning May Be Harder for Couples Without Children

You might think that estate planning would be easy when couples don't have children. In fact, it can sometimes be more difficult - and also more important.

Couples with children generally agree about passing on their assets to their kids, and can rely on their kids to serve as caregivers and executors. It might not be so easy for other couples.

For instance, suppose Mike and Helen write a will leaving their assets to each other. If Mike dies first, Helen will inherit everything. When Helen dies, who will get Mike's assets? Helen could make a new will, but if she doesn't, all of Mike's assets will go to Helen's relatives. 

But what about Mike's relatives? They would be left with nothing. And the same is true for Helen's relatives if she happened to die first.

Of course, Mike and Helen could agree that the surviving spouse will sign a new will that's fair to both families. But what if the surviving spouse gets remarried, or has a falling-out with the in-laws, or dies shortly afterward, or is elderly and simply doesn't get around to it?

A better approach might be for Mike and Helen's wills to say that if one dies, his or her assets will go into a trust. The trust can benefit the surviving spouse during his or her lifetime, and then go to the other spouse's family. That solves the problem

Another issue is who will serve as power of attorney or health care proxy. If Mike and Helen name each other, and one dies, who will be listed as the alternate for the surviving spouse? If there are no children in the picture, this requires very careful consideration. 

The Advantages of Making a List of Assets and Debts

Have you ever considered writing down a list of all your assets (with account number, passwords, and so on), as well as debts and recurring payments?

Making such a list and putting it in a secure place can be a godsend if something ever happens to you and you become incapacitated, because your family will have a much easier time looking after your affairs.

In a recent article in the Wall Street Journal, a middle-class couple described the extraordinary difficulties they faced when the wife's parents developed medical problems and could no longer handle their own finances. The couple had no idea what assets the parents owned, what insurance they had, where to find records, what bills needed to be paid, and so on. Handling the parents' affairs became a nearly full-time investigative job.

As a result of the experience, the couple resolved to maintain such a list for their own children.

The problem has only gotten worse in recent years, because of the proliferation of electronic reporting. In the past, bills and account statements would arrive regularly by mail, but now, many people access everything online. As a result, a family might never have the comfort of knowing they've located all of a person's assets.

If you make such a list, a good plan is to update it at least once a year, maybe when you do your taxes. The list has other advantages - for instance, you can always go to one spot if you forget an account number or a password. Also, reviewing and updating the list regularly can help you see what changes or improvements might be needed in your own estate planning.

Family Trust Could Prohibit Beneficiaries from Going to Court

People who set up trusts for children, grandchildren and other family members have a greater ability to limit the beneficiaries' right to challenge trustees' decisions in court, as a result of a new U.S. Tax Court decision.

Here's the background: You may know that you can give up to $14,000 a year to any person without incurring the federal gift tax. But that rule generally doesn't apply if you put the money in a trust for the person, because you're not giving them the money directly - in legal terms, the person doesn't have a present interest in the funds. So any such gift is potentially taxable.

So, how can you avoid this problem and put up to $14,000 a year into a trust without paying gift tax? A common solution is to put the money into a trust, but give the person 30 days in which he or she can withdraw the funds. Typically, beneficiaries won't actually withdraw the money, because they'll be afraid that if they do, no further contributions will be coming. But the 30-day window means the person has a present interest in the funds, and so you qualify to avoid the gift tax.

(A trust set up this way is often called a "Crummy Trust" after D. Clifford Crummey, a Methodist minister who pioneered the idea back in the 1960's.)

The new case involved Erna and Israel Mikel, a New York couple who over time transferred more than $3 million to a Crummey trust to benefit some 60 relatives. 

The trust documents said the beneficiaries could withdraw the money within 30 days (which no one did). The documents also gave detailed instructions for how and when the trustee could distribute funds to the beneficiaries over time, such as to help them pay for a wedding, buy a house, or get started in a profession.

Apparently the Mikels were concerned to prevent squabbles and lawsuits within the family, because they added a clause saying that if any beneficiary were to go to court to challenge a trustee's decision, that beneficiary would be cut off and could get nothing further from the trust.

That's when the IRS pounced. According to the IRS, this "don't-go-to-court" provision invalidated the whole plan, because it meant the beneficiaries didn't really have a present interest in the funds. If they demanded their money within 30 days and the trustees said no, the beneficiaries would be out of luck because they couldn't file a lawsuit, according to the IRS.

But the Tax Court sided with the Mikels. It said the "don't-go-to-court" provision didn't apply to a request to withdraw the money within 30 days; it applied only to future decisions by the trustees over whether to pay for a wedding, a house, tuition, etc. 

The ruling is good news if you want to create a trust for your family, but also make it less likely that your family members will later fight among themselves.

However, you still need to be careful. While the federal government lost this battle, some states also place their own restrictions on certain types of "don't-go-to-court" provisions.