Remarriage Finances Part 7: Special Financial Issues To Consider Before Remarriage--Estate Planning
By Joseph Warren Kniskern, Esq.
Remarriage Finances: Planning For A Family Merger — Not A Hostile Takeover
Part 7 — Getting Started As A Remarriage Couple: Special Financial Issues To Consider Before Remarriage--Estate Planning
In the previous article of our continuing series on financial issues, we considered general matters most couples face before remarriage begins--the "getting to know you" and financial planning stage of entering into a lifelong partnership. In this article (and the next one to follow) we will see how different and unique remarriage issues often change our goals and plans.
Remarriage is a complex mix of many personalities and financial issues. You cannot just consider income and expenses of the remarried couple in isolation. The couple needs to manage money coming from different purses, and often going into several different households. Into the mix is the past good and bad credit of each spouse and former spouses, good and bad spending habits of current and ex-spouses, and financial liabilities of all these individuals, just to name a few! Also thrown in are child-support payments, retirement plans, and college funds of children and stepchildren--not to mention all of the additional costs for food, day-care, entertainment and so many other daily expenses which test the strength of the blending family. It can be a monetary minefield!
Here are a few of the most important considerations:
Remarriage Estate Planning. How will your assets be passed along to your current spouse, children from your current and former marriages, and perhaps even your former spouse? The only way to know is by completing some estate planning.
Yes! Estate planning is a topic we'd rather not think about because it reminds us of our mortality. It is even more challenging to plan for the death of a remarriage partner before you marry! But then you hear the horror stories. Ana summed up the problem well, as she recalled her husband's sudden death from a heart attack at age 37: "No one wants to talk about how a survivor will sort out the details of a sudden death. I know I didn't. When my husband died, he had no Will and was underinsured. We both knew these were two areas we would eventually resolve, but we never did. Neither of us ever expected the other to die so young. If only I had prepared. If only I had followed the advice of our lawyer and our accountant." But the unfortunate fact is that three out of four Americans die without a Will. Financial planners estimate that approximately half of all Americans also are underinsured, or not insured at all. This lack of preparation can be devastatingly costly at a time of emotional upheaval, but especially with the additional complexities of a blending family!
Estate planning establishes long-term goals for managing, maintaining, and augmenting our assets and wealth in the event of our death. We plan for the most efficient and productive way to establish financial security, reduce taxes, and preserve what the Lord has blessed us with, for those loved ones who survive us. We do this through the use of gifts, wills, trusts, insurance policies and many other methods. This critical planning work is not only for wealthy individuals--everyone has a responsibility to exercise sound financial planning for the maximum benefit of the family.
One basic element of estate planning is to have a Will. This document provides assurance that your property will be distributed as you wish upon your death. If a person dies without a Will, which the law refers to as dying "intestate", his or her assets will be distributed according to applicable state law. And if the State decides how your property is going to be distributed, the odds are quite good that it will not be the way you would have wanted it to happen!
Too many couples entering remarriage have not even looked at their existing Wills. Imagine their surprise when they discover their Wills have not been changed since prior to their divorce--leaving their ex-spouse as the sole beneficiary of their estate!
Not only does a Will provide you with an opportunity to designate how your property is to be distributed, but it also allows you to select a trusted person or bank to act in your place as an "executor" or "personal representative" and to make decisions on matters after your death which are consistent with what you might want to do. Even more importantly, your Will states who should have custody of your minor children. However, if the other biological parent is still living and is not an unfit parent under the law, that parent will gain custody in most cases--notwithstanding the active daily parenting by a stepparent. (See our discussion of adoption and rights of stepparents in Chapter 9 of Making A NEW Vow for more information.)
Even so, you can still include specific child custody instructions in your Will. Why is this important? Because your ex-spouse may die before you do, or he or she may fail, neglect, or refuse to assume custody of your child even if the law allows it. Therefore, it is always important to have a guardian appointed in your Will, showing your intent, in case the other biological parent does not serve as custodian for any reason.
This situation uncovers a financial issue as well. Given the likelihood that your child may be turned over to his or her other biological parent in the event of your death, you may still want your child to benefit from your estate. However, you may not feel comfortable placing any of your estate assets into the hands of your ex-spouse. Therefore it is important to set up a trust for your child, and to name a trusted person to serve as trustee, to ensure estate assets do indeed go to your child. Without a trust, any money left to your child winds up in a court-directed guardianship proceeding--another very costly and time-consuming process! More importantly, a judge you have never met will decide how your money will be spent on your child. No thanks! In addition, without a trust, guardianships in many states end, when the child becomes a legal adult--still very young in years and maturity. What might your child do if he or she receives a large sum of money at that young age? Can you spell "Porsche"? For these and other reasons, it may be best to establish a trust for your child, protecting the money from your ex-spouse, and protecting your child against his or her own immature inclinations.
A Will must be probated at death. That means that when you die, your Will must be taken to your local county courthouse for a court supervised procedure, necessary to establish what you own, and determine who has the right of possession as you directed. The probate process also oversees payment of the taxes, claims and expenses of your estate. After all these probate procedures are completed, what remains of your assets is distributed to your beneficiaries. But probate is a costly and time-consuming process. Probate fees average approximately one to six percent of your estate (depending upon whether a Will contest occurs), with the average probate procedure taking many months to complete. A Will is a one-way ticket to the probate court. Consequently, depending upon the State involved, some remarried couples may want to plan their financial affairs in ways to avoid the probate process, if possible--especially if the process in your State is long and expensive.
One way to avoid probate is to have a living trust. You transfer your estate assets to your living trust, but nothing changes except for the title to those assets. Your life continues as it did before, with you having complete control over all of the assets in your living trust. When you die, a successor trustee that you select takes over your trust and can immediately distribute your assets, rather than wait for a long probate process to be completed. A word of caution here: Make sure your successor trustee is competent and trustworthy. Probate courts investigate and qualify personal representatives under Wills--no such court verification procedure is required in most instances for the successor trustee of a living trust.
Durable Family Powers of Attorney
Remarriage partners also need durable family powers of attorney in favor of a trusted agent(s) who will have authority to handle a spouse's financial affairs if he or she is unable to do so. A surviving spouse usually will be handling most of the family expenses upon any disability or death of the other spouse. This means making sure that the surviving spouse, or another trusted family member, has signing privileges on critical checking accounts and access to safe deposit boxes in order to keep the family afloat.
Estate and Gift Taxes
Part of estate planning also involves taking advantage of the tax laws. The Tax Reform Act of 1976 combined gift and estate taxes into a single tax applicable to gifts made during our lives, or estate inheritance transfers made to others upon our deaths. The massive Economic Growth and Tax Relief Reconciliation Act of 2001 also made numerous changes, which reduces applicable estate taxes over a period of years. The tax laws keep changing. Therefore, proper estate planning and compliance with the changing law keeps the amount of taxes paid to the IRS to a minimum. Your benefactors will enjoy more of what you want to give or bequeath to them.
The estate tax is a tax on the act of transferring property at your death--not a tax on the right of your beneficiaries to receive their inheritance. Your estate pays the tax. Therefore, the value of your property going to your beneficiaries will be reduced by the amount of tax that your estate pays. The good news is that every estate is allowed a deduction against the estate tax. This excludes some of your assets from estate tax liability. In 2001, the amount excluded was $675,000, meaning that if your estate was worth $675,000 or less, it may not be taxed at all on the Federal level. (States also may have inheritance taxes, so be sure to check with your estate planning advisor about planning for this additional expense.) Beginning in 2002, the exclusion amount gradually increases until it tops off at $3.5 million in 2009. You may think that you are not wealthy enough to exceed these thresholds, but once the value of retirement plans, equity in your home, and especially life insurance proceeds are added in, the value of your estate rises very quickly.
As part of this estate planning process, many couples establish revocable living trusts to reduce their tax obligations. They also set up their estate plans to take maximum advantage of a "unified credit" against estate taxes by having property in an amount equal to this credit transferred at the death of a spouse to a trust (usually called a by-pass or credit shelter trust), with the balance of the estate transferred to the surviving spouse to minimize or even avoid estate tax until the surviving spouse dies.
Estate planning for blending families
Yes, estate planning for remarried couples is unique--especially for those with a blending family. Typical "simple Wills" will not work in most situations involving a remarried couple. Why? Because most "standard Wills" assume that both spouses have only been married once, with all children born of that marriage, and with the couple considering everything they own as "theirs". These typical Wills further assume that each spouse's primary desire at death is to provide for the surviving spouse. In addition, estate planners counseling a couple in a traditional marriage, will have a goal of eliminating or postponing payment of estate taxes. This may work against the interest of biological children, as we shall see. The fact is that remarriages should not be treated as traditional marriages in estate planning considerations, especially when children exist from a prior marriage.
What are some of the problems remarried couples face in estate planning? Risk of misunderstanding provisions in Wills and trusts easily can arise unless the preparer of these documents carefully defines the intent of the spouses. For example, it is very customary for a parent to make special bequests to that parent's biological children in a Will. However, if that parent's Will only makes reference to the bequests going to "my children", the executors of the estate may think that the parent meant to also include the remarriage partner's biological children. This could be especially true if, for example, the parent raised the other spouse's children from infancy. This may not be what the decedent wanted. Therefore it is best to be clear and definite in one's estate planning documents. This may mean stating, "my biological children, meaning Susan and Jack only" to avoid any misunderstandings.
Sometimes a remarried spouse wants jewelry or antiques to remain "in the family", meaning with biological children. If a parent is not specific and clear about who will receive this valuable property, it may go to the stepparent, and eventually to his or her own biological children. These matters must be carefully addressed in all estate planning documents.
It is not unusual for a biological parent's children to resist accepting a stepparent as "their parent". This becomes important when their biological parent dies, since the children will view this event as the time to receive their inheritance. If the biological parent leaves this inheritance in trust for his or her children, but giving the stepparent spouse the right to receive income from that trust for the spouse's life (a "marital trust"), this effectively postpones the children's inheritance. Result? It could create many potential misunderstandings and emotional conflicts between children and stepparent. This is especially true when the stepparent is younger than the child's biological parent. In these situations, postponing the child's inheritance until after the stepparent's death has almost the same effect as disinheriting the child--particularly if the inheritance does not vest until the child is well into retirement. Also, the stepparent and biological child of the deceased spouse are tied to each other for life through the existence of the marital trust, even if it is not in their mutual best interest to continue the relationship.
There are ways to work around this problem, however. For example, it may be appropriate for the biological parent to give the stepparent a certain sum of money and/or a specific asset, while allowing the biological children to receive everything else. If this is not enough for the stepparent to maintain his or her lifestyle, life insurance on the biological parent's life could make up for the difference. (But be careful--estate taxes due on the biological parent's death could reduce the actual amount of life insurance proceeds received by the stepparent! In all events, always be sure to check with your estate planner or tax advisor on the various options first.)
Another way to direct your inheritance to your biological children is for each parent to set up a separate trust for their own children and to transfer their personal assets into the trust before remarriage. Each parent then names his or her own biological children as the beneficiaries of that parent's own trust. In most states, the children then will inherit the assets after their respective parent's death. In the meantime, each parent can enjoy the benefits of his and her respective trust as specified in their individual trust agreements.
Trying to balance the interests of biological children and stepparent spouses does not come easy--especially when estate tax implications are considered. Prior to 1982, remarried spouses were on the horns of a dilemma--did they leave their assets to the surviving spouse? That avoided paying some estate tax, but created problems with the children by postponing their inheritance. Or did they ignore the marital deduction against estate taxes and pass along everything to the children? Fortunately, Congress recognized this dilemma and enacted legislation permitting a transfer estate tax deduction, if the decedent's estate is passed into a "QTIP Trust". A QTIP Trust, which is properly qualified under the IRS Code, allows a spouse to make sure that his or her surviving spouse receives a lifetime income. But after that spouse's death, the trust assets will pass as directed by the Will or other instructions of the first spouse--typically to the first spouse's biological children. Be careful about this option as well, however, since certain features of this type of Trust may not be appropriate for all remarried spouses.
Selection of trustees
Many estate plans use trusts to manage assets, pay income, and pass along wealth to children. With remarried couples, it is often more prudent to have the trustee of these trusts be someone other than the surviving spouse. This is often necessary because of the inherent conflicts of decision, arising in how trust assets and income are best utilized--sometimes to the detriment of the children.
With a stepparent as trustee, children who are beneficiaries of the trust may be suspicious about the stepparent's objectivity and neutrality. The opposite also can be true. Children should not be trustees of a marital trust for the benefit of the stepparent, since partiality may exist and suspicions interfere with effective trust administration. Similar conflict of interest concerns arise with giving trust beneficiaries the power to remove trustees and select replacement trustees. In selecting a replacement trustee, it may be wise to require both the surviving stepparent spouse and the children to agree on the trustee candidate. Be sure to check with your estate planner or tax advisor about all these factors as well.
Usually, corporate trustees and banks provide the best alternative (provided that the administration fees are reasonable and affordable). However, a trusted family friend also may serve as a good compromise trustee candidate, if he or she can resist pressure from the beneficiaries when difficult choices must be made.
In our next article, we will investigate other vitally important financial issues such as housing, administration of retirement plans, social security benefits, coordination of insurance, titling of joint and separate assets, as well as support and liability issues with ex-spouses.