The following was presented by James W. Spencer in April 2015 at the KCBA CLE "Estate Planning for the 99%".
While estate planning for the 99% may be simpler than that for those facing significant estate tax issues, saving estate taxes is not always the greatest challenge in estate planning. According to the U.S. Census Bureau, blended families now outnumber traditional families, and in nearly half of all stepfamilies, one spouse or the other brings a child or children with them. Blended families can face complex estate planning challenges, not the least of which is ensuring that each spouse's share of the estate ultimately ends up with his or her desired beneficiaries.
A “blended family” is most often the result of:
- One or both of the planning spouses have children from a previous marriage;
- The children of the planning spouses being in a second or subsequent marriage and have children from a previous marriage; and/or
- The planning spouses’ children having a spouse with children from a previous marriage.
The focus of this presentation is on the first of those, though many of the estate planning methods discussed herein can be applied down the inheritance chain where the planning spouses want to include or exclude non-biological in-laws and grandchildren.
More often than not, estate planning for a non-blended family distributes an estate in its entirety to the surviving spouse, with the children as contingent beneficiaries, either directly of by way of a testamentary support trust for their benefit. Where the planning spouses share the same children, this schema is generally effective because presumably the surviving spouse is going to leave his of her estate to the same beneficiaries as the deceased spouse: the couple’s biological children.
In a blended family where the decedent has children, once everything is bequeathed to the surviving spouse, that spouse can easily amend the documents to disinherit whomever he or she chooses, including the deceased spouse's children (it goes without saying that this could happen even in the case of a surviving spouse/biological parent, but logic would dictate that this is far less likely.
This presentation highlights some of the best tools and practices available to protect the legacy of decedent spouses in a blended family who desire to provide for their children.
II. The Threshold Question: Should I Represent Both Spouses?
A threshold question for any attorney planning for a blended family needs to be whether he or she can represent both spouses in a blended family situation. There is no doubt that there exists conflicts of interest when planning for any two people, and this is heightened in a circumstance where the parties have different biological heirs.
This particular presentation is not one on ethics, but the wise practitioner will explore this concern very closely, discuss it in detail with his or her clients, and make a determination of whether joint representation is ethically sound.
Divorce is a fact of life in the fabric of American marriage. Data suggests that divorce rates are actually declining, but historically about half of all U.S. marriages will end in divorce. On average, fifty percent of those who divorce will end up marrying again (about 55% of men remarry, while 45% of women do).
Any recently-divorced client should review his or her estate plan, update his or her will to reflect the present marital status, and think about updating all the beneficiary designations on accounts and policies that name the former spouse as the beneficiary. These can include life insurance policies, annuities, bank and brokerage accounts, IRAs, and workplace retirement plans. The recently-divorced should also remove the former spouse as the joint owner of any real estate, cars, or other assets that were purchased together from the assets and accounts received in the divorce settlement.
Of course, all of this should be done in the context of any separation agreement of court-ordered property settlement, but this preventative work can make it easier on each ex-spouse if and when the time comes for them to remarry.
IV. Pre-Marriage/Marital Property Agreements
A prenuptial agreement is not only a great device to clearly spell out the interests of second-time-around spouses in separate and community property, but they can be an excellent way for parents who are remarrying to specify which of their assets they’d like to earmark for their children. A properly-executed prenuptial or postnuptial agreement can clearly delineate the nature of assets as separate or community, and prevent future transmutation of separate assets into community. Because community property laws prevent either spouse from bequeathing more than half of the community property by will, this can be a good safeguard to make certain there is no cloud on current or future assets intended for the decedent spouse’s children.
A. Joint, Mutual, and Reciprocal Wills
Wills alone may be an insufficient tool for blended families, as surviving spouses are generally able to revise property distributions to children after the death of the first spouse. Joint or mutual wills may prevent this, but their use has become less common over time for a variety of reasons explored below.
Reciprocal wills are wills that contain common or reciprocal provisions, but that are not necessarily executed pursuant to any agreement to make or not to revoke such a will. This term could be applied to most wills that are drafted for couples. The execution of reciprocal wills by two testators does not, without more, prove that the testators contracted not to revoke their wills, regardless of whether the testators are married. The result is that upon the death of the first spouse, the surviving spouse may inherit the decedent spouse’s entire estate, and then change any contingent property disposition to his or her liking.
Joint wills are reciprocal wills that are incorporated into one document that is executed by both testators as their respective wills, whereas mutual wills refers to reciprocal wills in which the two testators have contracted to make those wills and also contracted not to revoke them except under certain circumstances. The contract may be subject to the statute of frauds (for example, because it relates to real estate or because it is consideration for marriage), and the simple making of reciprocal wills is not sufficient part performance to satisfy the statute of frauds.
The burden of proving the contract not to revoke a will is on the person asserting the contract, and burden of proving the wills is the same as other will contracts. Unless the wills are proven to be mutual or there is proof of a contract not to revoke a will, any will or any reciprocal wills may be revoked by the testator at any time without any notice to the testator of the reciprocal will or to anyone else.
The remedy for a beach of a contract not to revoke a will is one or another of the usual remedies available for the breach of a contract: damages or an equitable remedy such as constructive trust or specific performance. As a result, even if a contract not to revoke a will is established, the will may still be revoked unilaterally, even after the death of the first spouse. This leaves children, who may have been named in the original joint or mutual wills, to assert their claim in accordance with applicable estate administration law.
B. No-Contest Clauses
A "no-contest clause," also known as an in terrorem clause, specifies that if a beneficiary challenges the trust or will, that person receives nothing or some token amount. No-contest clauses are valid in Washington, but a contest brought with probable cause will not result in a forfeiture of the legacy.
It has been held that a contest by one acting on the advice of an attorney will be deemed to be brought with probable cause (and in good faith) as a matter of law, but only if all material facts have been fully and fairly laid before the attorney prior to his advising the contest. The mere lack of success in a will contest does not indicate either bad faith or lack of probable cause.
Assuming that the prohibition is limited to contests, it may be difficult to determine just what a “contest” is. Cases have held that challenges that do not technically come within the term "contest" (because they do not go to the validity of the will and therefore are not within the "will contest" statute) would not be within the term "contest" in a no-contest clause.
C. Tangible Personal Property Lists
The use of a tangible personal property list pursuant to RCW 11.12.260, which permits the use of separate, unwitnessed documents to pass tangible personal property upon death, is an excellent way to ensure that family heirlooms and photographs stay in the family, and to ensure that children or grandchildren receive the individual items they admire. Post-marital tangible personal property, of course, is subject to community property laws.
A. Revocable Living Trusts
Perhaps one of the most effective tools for estate planning in a blended family is a revocable living trust. Each planning spouse can have their own trust, or the spouses can maintain a trust together. During the grantors’ lifetimes, the trust can be amended, changed, or terminated, and the grantors can take withdrawals and receive income from them. After the death of the first grantor (or the only grantor if each spouse has their own trust), the trust can be drafted to become irrevocable, wholly or in-part, locking in a set distribution for the decedent spouse’s children, while still providing for the surviving spouse.
The trust, when managed properly, also has the added benefit of providing for management of assets of the grantors if one or both of them become incapacitated, and avoiding the costs, delays, and headaches of probate.
A typical example of this would be as follows: upon the death of the first spouse, half of the couple's assets would be placed into an irrevocable trust for the benefit of the surviving spouse, who is able to live off of the income generated by that trust, while the remaining half of the original revocable trust assets remain at the disposal of the surviving spouse. Upon the death of the surviving spouse, the principal of the irrevocable trust is passed to the biological children of the first-deceased spouse.
Grantors can also spell out how the trust's assets are shared and spent:
- Per stirpes language which distributes the assets equally to each branch of a family if a child predeceases the grantor, ensuring that his or her children share equally in the assets the grantors intended for his or her parent.
- "Spendthrift" provisions that can protect a child’s share from wasteful and unwise spending, including the appointment of an independent trustee to control the funds on behalf of the child. Properly drafted, the trust’s assets are off limits to the beneficiary's creditors, including any future ex-spouse of the beneficiary.
- "Discretionary distribution" language which can direct the assets even more specifically, including earmarking trust proceeds to cover health care expenses, helping to maintain a beneficiary’s standard of living, purchasing a home, establishing a business, or paying for an education.
B. QTIP Trusts
Generally, the purpose of a Qualified Terminable Interest Property trust, or QTIP, is to provide income and, potentially, principal, if necessary, for a surviving spouse while preserving the underlying assets of the trust for the grantor's children or other designated beneficiaries. If the trust is structured such that the surviving spouse has at least a lifetime income interest in the QTIP, the grantor's funding of the trust qualifies for the unlimited marital deduction, which means than an unlimited amount may be transferred to the QTIP without federal estate or gift taxes being incurred on the transfer.
The QTIP can be drafted as part of a revocable living trust, as discussed above, or as a testamentary trust in a will.
An Irrevocable Life Insurance Trust, or ILIT, can be used to allow the death benefit from a life insurance policy to pass outside of the grantor's estate, therefore shielding the life insurance proceeds from federal estate taxes.
Typically, the grantor places money in the trust, and a trustee uses the funds to purchase an insurance policy on the grantor’s life. Because the grantor does not own the policy (it is owned bythe trust), the insurance policy is excluded from the grantor's estate, and the full value of the policy can go on to benefit survivors rather than a portion of it being paid in estate taxes.
Parents in blended families may choose to make their children the beneficiaries of the life insurance trust, while leaving assets outside of the ILIT to the surviving spouse.
An ILIT has another benefit: it can provide the liquidity a family may need to cover taxes on an estate. This advantage is especially helpful if the estate consists largely of relatively illiquid assets, such as retirement accounts, real estate, or a business.
Bear in mind that the first "I" in ILIT stands for "irrevocable." Money placed in an irrevocable trust is no longer available to the grantor, regardless of need. There may be gift tax implications related to funding the trust, both initially and on an ongoing basis, as may be necessary to support the trust's payment of life insurance premiums. For example, the annual and federal gift tax exemption amounts must be adhered to in order to avoid the application of federal gift taxes to the grantor's transfer of assets to the trust.
VII. Beneficiary Designations/Nonprobate Assets
Generally, beneficiary designations and other nonprobate dispositions will override a will if the documentation isn't consistent, and it is important to review these post-divorce and post-remarriage to ensure they are in line with the planning spouses’ goals. Note too that beneficiary designations on employment-related benefits will be subject to community property laws and ERISA, and dealing with those pre-death by way of a marital property agreement and, if appropriate, ERISA spousal consent, is key to ensuring that a decedent spouse’s bequest of these assets to anyone but his or her spouse will be effective.
Potential pitfalls abound when planning for the blended family. An attorney must be extraordinarily aware of potential conflicts of interest, and provide sound advice to individuals or couples that want to see some of his or her assets end up in the hands of their biological children while providing for a spouse who is not the biological parent of those kids.
Wills may be an ineffective tool for this type of planning, as the protections that may exist by way of joint or mutual wills could be difficult to enforce. No contest provisions in wills may help, and the associated tangible personal property list can be an excellent tool to get specific items to family members who aren’t the decedent’s spouse.
Trusts likely provide the greatest flexibility and protection in drafting for the blended family, and may offer additional benefits in spite of the additional associated production and management costs.
Finally, as always, non-probate assets must be monitored over time to ensure that their dispositions match the decedent’s intentions.