By Fredrick P. Niemann, Esq., an Estate Planning Attorney
Individuals don’t get serious about estate planning until they are well into middle age. By then, some of them are in second marriages. They are married, and one or both spouses have children from a previous marriage. Estate planning should be taken very seriously because each the spouse may want to provide for each other and their own children. If you’re in such a situation, proceed cautiously.
SECOND MARRIAGES AND YOUR RETIREMENT PLAN
In a second marriage, one or both spouses may have a sizable retirement account such as an IRA, SEP or 401 (k). One technique is to name the other spouse as primary beneficiary of the IRA, with the 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: Real trouble.
EXAMPLE 1: Tom Jones (no, not the singer) has $500,000 in his 401 (k). He names his wife Martha as the primary beneficiary and his three children from a prior marriage as the secondary beneficiaries. Thus, if Martha predeceases the children, they will inherit the IRA. Even if Martha does inherit the account, the balance will pass to Tom’s children at Martha’s death.
There are several mistakes in this approach. First, Martha can use the IRA at will as she takes required minimum distributions. She can take out all $500,000 at once, pay the income tax, and then either spend the money or give it to, her own children not Tom’s children.
Second, in this example Martha is a surviving spouse and only beneficiary of Tom’s IRA. Under the federal tax code, Martha can roll over Tom’s IRA to her own new or existing IRA (no other beneficiary can do this). Then Martha can name any beneficiaries she wishes, such as her own children.
In either example, there is no assurance that Tom’s children will see a penny of his $500,000 IRA.
How can Tom avoid this outcome if he wants to provide for Martha and his own children? One strategy is to divide his $500,000 IRA into two $250,000 IRA’S. He can designate Martha as the beneficiary of one IRA; his children can be co-beneficiaries of the second IRA. Alternatively, Tom can leave the entire $500,000 IRA to his children, who can spread out required distributions over their longer life expectancy and thus enjoy extended tax deferral. If Tom adopts this plan, he can leave other assets to Martha, depending on the size of his estate and her economic needs.
In second marriages, spouses also can create trusts in their estate planning. The first spouse might leave assets in trust for the surviving spouse, who will get the trust income and access to the trust principal. At the surviving spouse’s death, the balance of trust assets may pass to the children of the spouse who funded the trust. Some trusts can be qualified terminable interest property (QTIP) trusts and defer estate tax.
Trusts can play a valuable role in your estate planning. Trusts can cause problems in second marriages. With the situation described before, the trustee could be conflicted between investing for current income (which would benefit the surviving spouse) and investing for long-term growth (which would benefit the children). Also, the children may have to wait many years before receiving their inheritance if the first spouse to die leaves all of his assets to such a trust.
Dividing and separating out the estate might be a better option. Some assets could be left to the surviving spouse and some to the children, outright or in separate trusts. If the spouses fear that such a plan would leave insufficient amounts to the beneficiaries, they might buy life insurance and increase the total estate value.
If you have any questions about this post, please call Fredrick P. Niemann, Esq., a knowledgeable Estate Planning Attorney. He can be reached toll free at 888 800-7442 or by email at email@example.com/. For further information, go to http://www.youtube.com/user/NJElderLawCenter#p/search/0/8be14yDEeJc to learn more.