Many couples and spouses fail to get serious about estate planning until they are well into middle age. By then, one or both of them are part of a blended family with one or both parents having children from a previous family. Estate planning for such families can be tricky because each spouse may want to provide for each other and for 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 and/or 401(k), etc. One practice is to name the other spouse as primary beneficiary with the account owner’s children as 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. If Christine predeceases the children, his children will inherit the IRA.
There are two flaws in this strategy. First, Christine can tap the IRA at will while alive and at age 72 1/2 and she must take her required minimum distributions; or she can take out all of $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 a new or existing IRA (no other beneficiary can do this). Christine can then name any beneficiary she wants, 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 IRA’S. 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 their required minimum and 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.
Consider a Trust to Limit a Spouse’s Ability to Disinherit Children
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 may be given some limited access to the trust principal. At the surviving spouse’s death, the remaining trust assets may pass to the children of the spouse who funded the trust. A trust of this nature is called a qualified terminable interest trust (QTIP) and defers possible estate tax and limits a surviving spouse’s ability to disinherit David’s children.
Trusts can play a valuable role in estate planning. But 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 many years before receiving their inheritance if the first spouse to die leaves all of his/her assets to such a trust.
Dividing the estate is (in my opinion) the better solution. Some assets can be left to the surviving spouse and some to the children, outright or in separate trusts. If the spouse fears that such a plan would leave insufficient amounts to him or her, they might buy life insurance and increase the total estate value.
To discuss NJ estate planning, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com. Please ask us about our video conferencing or telephone consultations if you are unable to come to our office.
By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Estate Planning Attorney