by Michael Lackey, JD, CFP®
The term “blended family” evokes images of The Brady Bunch for members of the baby boom generation. Blended families have become more complex in the decades since the original airing of the show. ABC’s current television series Modern Family reflects the variations family structures may take today.
For BB&T Wealth clients contemplating second marriages or for those already in blended family situations, there are various financial issues that may need to be addressed. The first thing to consider is whether any prior relationship has been unwound as the parties have agreed. Have you removed your ex-spouse from the ownership of jointly owned assets? Have you removed them as beneficiary of retirement accounts, other financial accounts and insurance policies? Has your will or revocable trust agreement been updated to reflect the change in marital status? Have you made changes to prevent your prior spouse from controlling any inheritance your children will receive if you die prematurely?
Wealth clients concerned with protecting accumulated financial assets and the inheritances of their children from prior marriages should consider prenuptial or postnuptial agreements. These agreements are also useful in terms of securing future ownership of family-owned businesses and providing a level of certainty to parties entering the agreement in the event that the new marriage does not last. Full disclosure of one’s finances is required. Separate legal counsel is recommended.
The law regarding marital agreements varies from state to state, so it is essential to engage a qualified member of your state’s bar concerning the scope and extent to which these types of agreements may be effective in your situation. Marital agreements may potentially alter common law dower and courtesy rights, which entitle a surviving spouse to receive a portion of the estate of the deceased spouse. In many states, these common law rights have been replaced or altered by statute. For example, a wife might be entitled by state law to one-third of a deceased husband’s probate estate. If the parties decide to waive spousal rights to each other’s retirement plans other than Individual Retirement Accounts, it will be necessary to include a clause in the agreement that they will waive the rights upon vesting. The waiver and consent documents are then signed subsequent to the marriage.
In many situations, one new spouse may be substantially wealthier than the other. Here, it may make sense to allay the concerns and address the needs of the new, less wealthy spouse contemplating a marital agreement through a transfer of assets or creation of a trust. If this is done during marriage, the transfer will qualify for the unlimited marital deduction for gift tax purposes if it is done outright or to a qualified trust. Such a trust could be funded before or after the death of the wealthier spouse.
In fact, it is common for wealthier spouses to incorporate provisions for a Qualified Terminable Interest Property Trust (QTIP) in their estate plans. The initial objective of the trust is to provide a lifetime source of income for the surviving spouse, with discretionary principal, if needed. Upon the death of the surviving spouse, the remainder is distributed to others as the final objective—for example, to the children of a prior marriage of the wealthier spouse who created the trust.
Life insurance is often a useful tool in dealing with blended family arrangements. In the context of a marital agreement, the wealthier spouse may choose to obtain life insurance with a death benefit payable to the less wealthy spouse. The parties to the agreement will need to determine the amount of the death benefit, how the policy will be owned, and who will be responsible for premium payments. They will also need to determine if term or permanent insurance is appropriate. Life insurance owned by an Irrevocable Life Insurance Trust (ILIT) could be deployed in similar fashion to the QTIP trust described above. In this way, the insurance proceeds fund a trust for benefit of the spouse for life, with remainder to children. An ILIT is an advantageous method of owning life insurance in the sense that it is not individually owned and thus the death benefit is not included in the insured or beneficiary’s taxable estate.
Many of our Wealth clients own a business as their single largest asset and source of income. Sometimes tension arises for blended families involving these family-owned businesses. For example, a client in a second marriage may own a business that he or she wishes to transition to a child or children from a first marriage. The challenge for the owner then becomes balancing the income need of the second spouse with the desire to transfer business ownership to children. A potential solution is an Intentionally Defective Grantor Trust (IDGT). The process begins as an owner gifts a small portion of company shares to the trust. The owner then sells a larger block of shares to the trust. The owner takes back a note for the larger block, and the income from the interest flows back to the owner (and spouse). The children working in the business are the beneficiaries of the trust, and the shares are ultimately distributed to them. If the owner dies before the note is paid, then the spouse may continue to receive the income stream from the note until it is paid. In other words, the surviving spouse may become a creditor of the business but not a co-owner. This is a complex arrangement that works for companies that generate strong cash flows. It also requires a good deal of input from your accountant and attorney.
Ultimately, balancing the financial and emotional needs of blended families is no easy task. Proper planning can help remove some obstacles to harmony within the blended family.
Michael Lackey earned a B.A. from Wofford College and a law degree from Woodrow Wilson College of Law. He is a member of the State Bar of Georgia, a member of the Greenville Estate Planning Council and a Certified Financial Planner.
This article originally appeared in the Spring 2013 issue of Wealth magazine.