April 2023
Jim Farmer is Managing Partner of Financial Strategies Group, a leader in the insurance industry providing clients with practical solutions.
Blended families seem to be becoming the rule and not the exception. There are many different configurations of blended families, but they are generally made up of married couples who have children from previous marriages or relationships. Along with providing guidance on the unique estate planning decisions these families face, advisors also need to be prepared to navigate the emotional issues that come from those decisions in order to help their clients achieve their goals and maintain family harmony.
There are several estate planning options advisors can guide blended families on to ensure the outcome is as they intended and that every family member is included.
Wills
Start with the fundamentals by helping clients create a will to handle basic matters such as naming an impartial executor and a responsible guardian for underage children. The will should also provide for a power of attorney and healthcare proxy should someone become incapacitated. While wills can provide instructions for how to distribute many client assets, it can have a number of limitations, so advisors should consider whether their clients would benefit from additional tools, such as trusts.
For example, remember that wills do not dictate the beneficiaries for life insurance policies or retirement plans or jointly owned property. Wills are subject to probate, and this can be a lengthy and expensive process that opens the door to having instructions in clients’ wills challenged in court. Also, a will becomes a public document and leaves clients little to no privacy in their financial affairs.
Trusts
Trusts allow clients greater control over how assets in a trust are managed and distributed, and, unlike wills, trust documentation is private. Different versions of trusts can accomplish specific goals for a blended family. A qualified terminal interest property trust (QTIP) can provide income for a surviving spouse while passing along the rest of the assets to a client’s children or grandchildren.
Another type of trust is designed to pass over a generation and distribute trust assets to grandchildren or others who are at least 37.5 years younger than the grantor. Some clients may choose to use this generation-skipping trust (GST) to help keep wealth in the family by bypassing children who have remarried.
Making an IRA legacy trust the beneficiary of an IRA instead of family members is also an option for advisors and their clients to consider. First, it allows clients to maintain a level of creditor protection that is not always carried through to a person who inherits an IRA. Additionally, a client may want to use an IRA’s required minimum distributions (RMDs) to benefit a second spouse during their lifetime and to leave the remainder to their own children.
Despite the various names for trusts designed to meet specific needs, there are just two main types of trusts: revocable and irrevocable. Revocable trusts are often called living trusts and can be changed after creation. This is not the case for irrevocable trusts, which people commonly use to move assets out of an estate for tax purposes and for creditor protection. Advisors should engage the services of a trust and estates planning attorney for this part of the process to help design and implement any trust solution a client is considering.
Life Insurance
While some people use life insurance for estate planning in order to pay transfer taxes, advisors should also explain the challenges it can help solve for a blended family that wants to mitigate inequity and provide for every member. Instead of following a will’s directive or a trust’s beneficiary instruction, a policy’s beneficiary listing determines who receives the death benefit. This means that clients can provide liquidity to family members who do not inherit other assets that may not be easily divided or earmarked for all heirs.
In many states, there are laws about how much of the estate a surviving spouse must inherit. Clients can use life insurance to ensure they leave enough for children and grandchildren from a prior marriage.
Prenuptial Agreements
Make sure clients who are getting remarried are on the same page with regard to what assets each spouse is entitled to upon the death of the other or in the event of divorce, as well as whether they agree to waive their right to contest these commitments. A prenuptial agreement is a legal contract that spells out these terms and is executed prior to marriage. In many instances, a prenuptial agreement requires each spouse to maintain life insurance on the other to ensure a level of liquidity, either from a policy’s death benefit or from its cash value.
Advisors can also help clients create prenuptial agreements that pass separate property to children from prior relationships, clarify financial rights and responsibilities, and explain how to address any existing and future debt. Perhaps of equal importance to these goals, a prenuptial can serve to help prevent arguments in the case of a divorce. Advisors should prepare to be met with some emotion by clients when they sit down to address all of these areas.
Being Clear And Current
A final consideration for advisors is that all the documentation created to ensure a client’s wishes are carried out could be rendered useless if any of it is difficult to understand, unclear or wordy. For example, make sure that you spell out the full names of beneficiaries for wills, trusts and life insurance, and include their birthdates so it is easy to identify them and they can’t be confused with someone else. No more than two years should pass without a client reviewing all documentation to make any revisions or updates so that there can be no mistake about the client’s intent. Financial and estate planning is an ongoing process that advisors should revisit with clients to keep documentation consistent with their evolving needs and goals.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.