Planning for the Second Time Around

Planning for the Second Time Around

Planning for the Second Time Around

Vaughn W. Henry

Although nobody likes to enter a marriage thinking about the potential for problems, they happen. It’s a statistical probability that some marriages will fail, no matter how genuine the couple’s romantic intentions. Second and third marriages are particularly prone to uncertainty, as both parties are usually older and less flexible. There are often children from previous relationships and the couple may bring considerable assets or debts into this new marriage. It is these commingled assets and liabilities that cause serious disputes when the union starts to split apart. Deciding early on what is mine, yours and ours is important, otherwise it becomes a constant source of irritation in a blended family. To deal with complex financial problems while both parties are alive is difficult; it’s overwhelming to deal with family issues after a death.

While property held in joint tenancy passes to the surviving owner, any remaining assets may be up for grabs. Unless the surviving spouse has waived the statutory right to the deceased’s estate, any children from an earlier marriage may be effectively disinherited. This right to disclaim effectively puts the step-parent in line for one-half of the estate, despite the late spouse’s original intentions. Worse yet, the children of the surviving spouse may ultimately walk off with the bulk of both estates, leaving the first family cut out of the loop.

This unpalatable situation can be remedied with a series of trusts designed to preserve each family’s original assets. Notably, the QTIP (Qualified Terminable Interest Property) or ABC Trust allows each spouse to direct how their assets will be distributed, while still providing lifetime security for the surviving marriage partner. Assets placed in a properly drafted QTIP Trust qualify for the unlimited marital deduction, and this action postpones any estate taxes normally due at the first death. The QTIP also reduces the possibility of assets passing out of the original family’s control due to a future remarriage of the surviving spouse. This specialized trust is particularly useful in protecting children of a previous marriage from being disinherited by the surviving step-parent.

Less obvious problems in second marriages include being inattentive about beneficiary designations on insurance policies and retirement plans. All too often, the ex-spouse receives an unexpected windfall, while leaving estate taxes and final expenses up to the new family. Most companies will provide beneficiary change forms for insurance, annuities and qualified retirement plans, so there is no excuse for making this oversight..

Estates of married couples that are under $650,000 (including life insurance) and not likely to exceed this amount in the future use different planning techniques. While smaller estates will generally not benefit tax-wise from either the traditional Credit Shelter or QTIP Trust, a living trust and durable powers of attorney are still valuable tools. Families below the federal estate tax threshold still can unintentionally lose assets to another family, and this is a serious problem requiring good planning.

Many legal specialists recommend prenuptial agreements to minimize potential disputes and protect assets. However, some clients are uncomfortable with the complete disclosure needed to make these contracts binding. Other planners suggest the use of Family Limited Partnerships (FLP) as a way to protect assets and insulate the children of previous marriages. Assets held in these specialized partnerships allow the parent, as general partners, to still control both income and management. Children, on the other hand, as limited partners, are treated as passive investors in the family assets. Since the future heirs already have paper ownership of the family assets, there is little chance of losing them to another family. Of special interest to parents is the creditor protection provided to family business assets held by a FLP. Asset protection for limited partners is based on the inability to force a partnership to relinquish property. Although a judge may issue a charging order that allows a creditor access to the partnership distributions, the creditor only takes the place of the limited partner. However, the general partner still controls the timing of income distributions. As a result, creditors may find themselves in the unpleasant position of receiving tax liabilities from the partnership, but having no income distributed to pay the bill. Most creditors would prefer to avoid that situation, and this provides heirs with some leverage for negotiations.

For the more determined clients, an international trust may provide a mechanism to better protect and control the original family’s assets. Although there are a lot of hoops to jump through in order to keep everything legal, these trusts offer many advantages for individuals with potentially big exposures. To keep from conveying property fraudulently, planning must occur before any litigation or threat of legal action occurs. The major advantage to holding assets off-shore lies in the difficulty of attaching assets in any legal action. Most judges feel that such assets are held outside of their jurisdiction and not subject to the court’s control. Other asset protection features of these trusts include blocking frivolous litigation by forcing all proceedings to occur in the foreign country where the trust is located. This hurdle prevents most lawsuits from moving in directions unfavorable to the client. To evaluate the best use of asset protection strategies and integrated estate planning, experienced legal, tax and financial advisors should be consulted.

Vaughn W. Henry deals primarily with planned giving programs and estate conservation work and is a member of the Central Illinois Planned Giving Council.