Estate planning for families that include children from parents who have been married a couple of times can be complex. Sometimes ensuring that all the children are treated fairly means you may need to take measures to protect their inheritance if you die prematurely. Your current spouse may not have any emotional tie to them so they could disinherit them either innocently or with malice.
Consider the following example of a husband and wife who both have children from prior marriages and have a child together:
Consider the following:
- If John predeceases Mary: Assume Mary has no affection for or relationship with John’s children from his prior marriage. At her death, she leaves them out of her will, and they are left with nothing from John, (who had a simple “I love you” will that left everything to Mary). They are effectively disinherited through a bad sequence of events and poor planning unless their mother Sue (who may or may not have much of an estate) leaves them something. Or if Sue is married and leaves everything to her new husband he could leave everything to someone else effectively leaving no inheritance for John and Sue’s children. This means that things John (and possibly Sue) might have worked hard for never benefit their own children from their marriage.
- If Mary predeceases John: John remarries, he marries a much younger woman who outlives him; since Mary left everything to John, her child from her first marriage could be disinherited if John leaves everything to his new wife who will most likely out live him. Or his younger wife could still care enough about Mary’s son that she does leave him something but John’s young wife may live for many more years meaning any inheritance Mary’s son would have received may be delayed for 20-30 years.
Those are just two of many possible sequences of events. While every scenario cannot be anticipated some estate planning techniques can reduce the risk that someone’s children are not left out in the cold. Here are two.
QTIP Trust (Qualified Terminal Interest Property) – Is a testamentary (created through a will at someone’s death) trust used by married couples to control the disposition of assets in their estate after the death of their spouse. John’s will would create the trust and specify which assets that he owns individually will be in the trust. Assets he leaves to the trust will qualify for the unlimited marital deduction if his executor makes a QTIP election on his estate tax return. A requirement for those assets to qualify for the unlimited marital deduction is that his wife Mary must receive all the income generated by the assets for the remainder of her life. The assets in the trust will also be counted as part of her gross estate at her death. John though has designated who will receive the assets at his wife Mary’s death and that choice is irrevocable. Using this estate planning technique, he can make sure that his children are never disinherited.
Mary can also include this type of trust in her will to protect her the legacy of her son from her first marriage.
Unfortunately, a QTIP trust is not the most appropriate technique if a person has the bulk of their assets in IRA’s, 401K’s, or other qualified types of accounts that will become subject to the Required Minimum Distribution rule. The reason is complex and related to the requirements that all income from the assets in a QTIP trust be distributed to the remaining spouse every year. The definition of income for an IRA may clash with the definition of income under some state’s rules regarding trusts.
Irrevocable Life Insurance Trust (ILIT) – Another and perhaps more appropriate method of protecting children in a mixed family circumstance is life insurance combined with an Irrevocable Life Insurance Trust (ILIT). Here a trust is created while the spouse is living (unlike a QTIP which is typically created at death through a will). The trustee of the ILIT applies for life insurance on the life of the spouse and the trust owns the policy, the spouse pays the policy premium each year by gifting funds to the trust. The trust is created for the benefit of whomever the spouse selects, in this case possibly a child. At the death of the spouse the life insurance is paid to the trust which may then invest the proceeds and pay the income to the child, provide them with rights to the principle under certain conditions (maintenance, education, support, or health) and perhaps gradually pay the corpus out to them at specific ages (25, 30, 35, for example). This type of trust has other benefits including protection of the assets from the child’s creditors. This is a short and simple summary of this type of trust which could accomplish many of a parent’s goals for the protection or creation of a legacy for their children, one not affected by remarriages. It does come at a cost though, the cost of life insurance and the requirement that the spouse be insurable. It is also recommended that the spouse consider setting this trust up when they are younger and the cost of life insurance is less.
Here is a summary of the 2 approaches:
|QTIP Trust||ILIT Trust|
|When Created||At First Spouse’s Death||During Lifetime|
|How Funded||Assets that qualify for marital deduction||Life insurance purchased by trustee|
|Duration||Does not benefit child until second death||Benefits children at the death of their parent (first death)|
|Income Beneficiary||Must be spouse to qualify||Child(ren) or anyone chosen|
|Restrictions||IRA’s are not appropriate to fund the trust||Can be life insurance but may also gift other assets (not IRA’s)|
|Cost||Typical costs for trust management||Life insurance premium and typical trust management costs.|
|Advantage||Spouse controls disposition of assets after their death||Benefits children at their parent’s death (no wait for the second death of a step-parent).|
|Disadvantage||Child may not receive inheritance for years. Asset may be depleted by remaining spouse||Cost of life insurance.|
This is a brief non-technical summary of a couple of approaches to consider if you do have children from prior marriages.
Stephen Craffen MS, CFA, ChFC