Tuesday, February 19, 2013

Estate Planning for a Second Marriage

     Recently a colleague asked for information about the use of trusts in estate planning following a divorce and remarriage. Since we have not addressed this topic yet, a post on the subject seemed appropriate. It is important for client to consider estate planning issues following a divorce and remarriage to avoid inadvertently disinheriting either the new spouse or children of the first marriage. Clients (husband and wife) in their first marriage usually have common goals, such as providing for the surviving spouse during their lifetime and leaving any remaining assets to their children equally. This makes estate planning relatively simple, because a living trust holds the assets to limit tax liability, avoid probate, and ensure the assets pass to the surviving spouse for use during the spouse's lifetime and then on to the couple's children.
     Clients in second marriages, whether because of divorce or death, usually have a more complex situation with which to deal. In those circumstances there are concerns regarding the surviving spouse, children from the first marriage, the surviving spouse's children, and possibly children from the second marriage. Clients wish to ensure the surviving spouse has sufficient assets during lifetime, while also ensuring that the assets they brought into the marriage eventually pass to their children.
     A frequent concern of clients in their second marriage is ensuring that both their second spouse and their children receive gifts following the client's death. A common technique used to achieve this goal provides the surviving spouse with a regular stream of income from the trust assets, while reserving distributions of principal for the client’s children following the death of the surviving spouse. When using this technique, it is also common to provide the trustee with the discretion to make distributions of principal to the surviving spouse, under a limited set of circumstances, to ensure that the surviving spouse has sufficient assets to live on following the first spouse's death. It is important in these circumstances that the trustee understand that part of their responsibility is to balance the best interests of both the spouse and children from the first marriage in making distributions. It is a good idea for the client to discuss these issues with the named trustee.
     Alternatively, some clients opt to address this issue by distributing different assets to their surviving spouse and their children. For example, a trust might provide that the client’s children receive immediate distributions from the trust assets equal to the payout from a life insurance policy. The client may also provide that the children are beneficiaries of the client’s IRA or other retirement accounts. The trust then provides that the client's surviving spouse receive all income from the remaining trust assets, and gives the trustee broad discretion to make distributions of principal for the surviving spouse's needs. Any trust assets that remain following the death of the second spouse are distributed to the client’s children. This technique ensures that that the client’s children receive an immediate gift as well as the potential for additional assets should any remain after ensuring that the surviving spouse has sufficient assets during the their lifetime.
     A well-drafted trust is required to make use of these techniques because you need an entity maintain the trust assets instead of passing those assets directly to the surviving spouse. During a first marriage, a common technique for probate avoidance is to own property jointly with rights of survivorship. This allows the surviving spouse to remain the sole owner of the property following the first spouse's death without the property passing through probate. If this same technique is used following a second marriage, the surviving spouse becomes the sole owner of the property or bank account and then is free to do with that property whatever he or she chooses. This means that property the client intended for children to inherit following the second spouse's death could pass directly to the second spouse's children or family and completely disinherit the client's children from the first marriage.
     There is not always controversy about who inherits which assets. In many second marriages, spouses and their children from first marriages live in perfect harmony. Even in these circumstances, the spouses may wish to ensure that particular assets, such as vacation homes or collectibles, that each has brought into their second marriage are eventually inherited by their own children. With proper planning, it is possible to maintain these separate assets for both spouses’ use while ensuring that after the second death the assets will go to each spouse’s children, while assets earned jointly during the marriage are split equally amongst all the children.
     It is clear that the circumstances that exist when contemplating estate planning for a second marriage involve a level of complexity that generally does not exist when planning during a first marriage. These circumstances can become even more complex if either spouse’s children has special needs, dependency issues, creditor problems, or if there are significant personal conflicts between children and second spouses.  You may actually have a case where the new spouse has his or her own issues, which need to be addressed. An example of this occurs if the new spouse has an unpaid federal income tax liability and the spouse transfers a residence originally owned individually to the other spouse as joint tenants. Now the IRS can attach a lien to the residence. It is important to speak with an experienced attorney to ensure that the estate plan meets the goals of both spouses and is implemented with a minimum of conflict.

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