Changes in society and the law, some not even directly related to the estate-planning practice, have had a profound impact on the estate-planning world and caused it to evolve. For example, Congress introduced the generation-skipping transfer (GST) tax with the 1986 Tax Reform Act.1 They intended to limit the use of trusts and other transfer techniques to avoid estate tax at one or more lower generations. What they didn’t intend was the expanded use of lifetime/dynasty trusts to take advantage of the GST exemption and, ultimately, the repeal of the rule against perpetuities in some states to enhance the tax savings provided by such trusts.
Sometimes, however, these fundamental shifts occur not from a change in the law, but from a gradual change in societal norms. One aspect of society that’s evolved significantly over the past 25 years is the institution of marriage.2 Once upon a time, Mae West was quoted as saying, “Marriage is a great institution—I’m just not ready for the institution.”3 This sentiment indicates that, for better or worse, marriages on the whole used to last forever. It’s not that way anymore. U.S. Census Bureau statistics show that the average marriage in the United States lasts seven years, 50 percent of marriages end in divorce and 75 percent of individuals who divorce remarry.4
These changes have produced the “blended family” and have had a profound impact on estate planning. As societal norms evolve, so too does the definition of a “typical” client. With high divorce and remarriage rates, estate planners are encountering with increasing frequency, clients in their second or third marriage who have children from prior marriages. For purposes of this article, a marriage meeting these two elements will be referred to as a “blended family.”
A Simpler Time
At one time, the estate-planning environment was fairly stable. The typical clients consisted of a husband and wife, first marriage for both, with children and an estate in excess of the estate tax exemption amount. The estate plan would include the standard tools: wills, powers of attorney (POAs), other ancillary documents and an irrevocable life insurance trust (ILIT). The documents would yield the traditional results: (1) on the death of the first spouse to die, the estate would be funded into a bypass trust up to the exemption amount, and the balance of the estate would pass to a marital trust; (2) the surviving spouse would be the trustee of both the bypass trust and the marital trust and would be the primary or sole beneficiary of each trust; (3) on the death of the surviving spouse, the assets in the bypass trust, the marital trust and the surviving spouse’s estate would be combined and divided into equal trusts for the benefit of the children; (4) the children’s trusts would terminate at a fixed age or in stages (for example, one-half at age 30 and one-half at age 40); (5) on the death of the surviving spouse, the ILIT would receive the insurance proceeds from a survivorship policy, and those funds would be available to loan money to or buy assets from the survivor’s estate to enable that estate to pay the estate tax; and (6) in their POAs and other ancillary documents, each spouse would name the other spouse as the person to be in charge of their finances and medical care in the event that they became incapacitated.
A New Approach
For a traditional family, estate planning is typically accomplished for both spouses on a coordinated basis with shared objectives. However, the emergence of the blended family demands a new approach to planning that will balance the spouses’, often divergent, interests. (Please note that this article doesn’t address the complex ethical issues involved in representing both spouses in a blended family.) Most of the traditional assumptions must be set aside. For example, inserting a surviving spouse as the beneficiary and trustee of a bypass trust may be contrary to a client’s wishes. Instead, the client may wish to use his estate tax exemption and GST exemption to structure the bypass trust as a dynasty trust for the benefit of his descendants from a prior marriage.
In addition, the estate planner must be more proactive in identifying marital property issues, most of which will tend to arise at the end of the marriage. In a traditional family, the division of property during a divorce can be a contentious matter, but the division of the estate on the death of the first spouse to die is typically a smooth operation. This isn’t necessarily the case in a blended family, when the death of a spouse can result in the same degree of conflict that one expects in the divorce context, especially when there are children from prior marriages.
While there are many issues to be considered, as a general rule, the process of crafting an estate plan for a blended family will be successful if the estate planner abides by two guidelines: (1) take the time needed to identify the individual objectives and desires of each spouse; and (2) be prepared to use creative, alternative means to accomplish the individual objectives of each spouse, as well as their common goals, and to protect against the marital property “traps” that can yield unintended, painful consequences.
With these guidelines in mind, estate planners can avoid common pitfalls. Even though no two families will have identical planning needs, certain aspects of the blended family planning process are hotspots for conflict, and it’s the planner’s responsibility to identify these hurdles. The following discussion highlights specific issues that can arise in planning for a blended family and provides a strategy for how to effectively confront each issue.
A valuable gift-planning tool involves the use of the gift-splitting election. Internal Revenue Code Section 2513 allows spouses to elect to “split gifts” for transfer tax purposes so that a gift made by one spouse is treated as having been made one-half by the donor spouse and one-half by the consenting spouse. This treatment, in effect, allows a donor spouse to double the amount of a gift that qualifies for the gift tax annual exclusion. For example, suppose Wendy, in a traditional marriage to Harry, desires to make annual exclusion gifts (but not taxable gifts) of her separate property each year to dynasty trusts for the benefit of her and Harry’s grandchildren. In addition to using her available annual exclusion amount and GST exemption, she can double that annual gift if her husband consents to the gift-splitting election, thus applying his annual exclusion and GST exemption to those gifts. In this situation, the husband will typically consent.
Now, suppose Wendy and Harry both have children and grandchildren from prior marriages. Wendy plans to gift some of her separate property to dynasty trusts that benefit her grandchildren. Harry has no reservations about gift splitting for purposes of using his annual exclusion amount for those donees, but because he wants to preserve his GST exemption for gifts to his own descendants, he doesn’t consent to gift splitting.
One problem arises if the estate planner allows the plan to go forward and Harry unknowingly allocates his GST exemption to the gifts. Alternatively, if Harry knowingly balks at the election, Wendy must limit her gifts to her annual exclusion amount.
You can plan around this situation by having Wendy make an annual exclusion gift outright to her grandchildren, taking advantage of IRC Section 2642(c), which treats outright gifts to grandchildren that qualify for the gift tax annual exclusion as automatically exempt from the GST tax. If, however, Wendy insists that the gifts are to be made in trust, she could create individual trusts for each grandchild. Gifts to these trusts will qualify for the Section 2642(c) automatic exemption from the GST tax if the following conditions are met: (1) each grandchild is the sole beneficiary of his trust; and (2) if a grandchild dies before the trust terminates, the trust assets will be included in the child’s estate for estate tax purposes (typically accomplished by giving the child a testamentary power of appointment over trust assets).5 In this manner, the only cost to Harry will be the use of his annual exclusion for those grandchildren, so Wendy can make the full tax-free gift to her grandchildren that she desires, and conflict regarding the sharing of exemptions is averted.
Planning for incapacity is a comparatively simple aspect of estate planning, but for blended families, it’s important not to overlook, or “rubber stamp,” who will serve in the various fiduciary roles (for example, medical POA, POA, declaration of guardian, etc.). While, in traditional families, the spouse almost always serves as the first in line to fulfill the necessary roles, in blended families (especially those that have children from a previous marriage), a child of the spouse may be best suited (and the client’s first choice) for this responsibility.
When conducting incapacity planning, estate planners must pay close attention to each document, anticipate potential conflicts and ask the tough questions: Who does the husband/wife want to make medical or financial decisions for him/her? Who can best handle the responsibility? And, who’ll be least likely to cause conflict within the family? Thoughtfully considering the details of each decision and encouraging clients to make realistic assessments of their families is the best way for estate planners to meet the needs of a blended family.
Retirement Plan Assets
Blended families can spring from the death of a spouse, but as shown above, they’re frequently formed after a divorce. Retirement accounts are often the most valuable assets owned by spouses, and when the participant of a plan is divorced, it’s likely that the retirement account was an important piece in the property settlement. The 2009 U.S. Supreme Court decision in Estate of Kennedy v. Plan Administrator for DuPont Savings6 offers an important warning to planners in this area. In that case, a husband had designated his wife as the beneficiary of his retirement plan. When the couple subsequently divorced, the now ex-wife waived any entitlement to the benefits. Even though the divorce decree incorporated the ex-wife’s waiver, the decree failed to meet the requirements of a qualified domestic relations order, which is the vehicle by which beneficiary designations can be changed pursuant to the Employee Retirement Income Security Act.7 In addition, the husband didn’t take the steps to change the beneficiary designations on the plan. The court ruled that, on the husband’s death, the plan administrator acted properly in paying the husband’s benefits to the ex-wife, in accordance with the beneficiary designation on file.8
Regardless of the type of retirement plan at issue, beneficiary designations are a significant part of a client’s estate plan and can be a considerable source of conflict. Accordingly, estate planners must be meticulous when reviewing and implementing a client’s estate plan after a divorce, including properly structuring (and restructuring) all beneficiary designations.
Other Non-Probate Assets
Beyond retirement benefits, other non-probate assets also have the potential to cause problems for a blended family. Typically, non-probate assets are a convenient, hassle-free way to transfer assets on death, but in a blended family situation, an estate planner must maintain a clear understanding of the applicable state survivorship laws. A misunderstanding regarding the effect of survivorship language can yield disastrous results. Take, for example, the Texas case of Holmes v. Beatty.9
In Texas (a community property state), on the death of a spouse, one-half of the community property passes to the decedent’s estate and one-half passes to the surviving spouse. Texas law allows spouses to change that outcome and have the whole pass to the survivor through a properly executed survivorship agreement.10 In Holmes, a husband and wife (who each had children from prior marriages) had over $10 million in brokerage accounts and securities issued from the accounts, all of which were, undisputedly, community property. Both the husband and wife signed all of the account agreements, and although they didn’t intend to include survivorship language, the brokerage accounts were variously listed as: “JT TEN”; “JT TEN defined as ‘joint tenants with right of survivorship and not as tenants in common’”; “JTWROS”; and “Joint (WROS).”
The Texas Supreme Court held that the brokerage account agreements established rights of survivorship, explaining that “[p]recedent, trade usage, and seminal treatises make clear that joint tenancies carry rights of survivorship.” Thus, on the wife’s death, her interest in the accounts and securities passed by right of survivorship to her husband, and when the husband died nine months later, all of the interest passed under the husband’s will, which left nothing to the wife’s children. If the family in Holmes had been a traditional family, this outcome would have had a relatively benign result. However, with the added complexity of a blended family, the wife’s children were cut out of $5 million, which demonstrates how state survivorship laws can have unintentional and drastic estate planning implications.
Estate planners, however, can’t simply be familiar with the survivorship laws of their own states. Sometimes, clients purchase property in other states, and it’s the estate planner’s duty to spot possible survivorship issues. For example, suppose in a blended family situation, Harry and Wendy (residents of a community property state) decided to purchase a vacation home in another state. On the death of the second spouse to die, they planned to leave the house to Harry’s siblings (whom Wendy had never met). Harry and Wendy purchased the house with community property and engaged an attorney in the state where the home was located to handle the purchase. The resulting deed listed both Harry and Wendy as the owners of the real estate. When Harry later died, his siblings were less than pleased to discover that under the laws of the state where the house was located, titling the house in both Harry and Wendy’s names without any other language resulted in a tenancy by the entirety and, on a spouse’s death, 100 percent of the ownership passed to the surviving spouse.
Planning pitfalls are present with any client, but with blended families, the stakes are higher. An estate planner must remain vigilant, identifying objectives and potential traps that may result in unintended consequences, family conflict or otherwise cause the estate plan to fail. As both laws and societal norms change, the goals of estate planning remain the same. Estate planners must simply adapt their strategies and techniques to continue to achieve the ultimate goal: an effective and workable estate plan that fully accomplishes the client’s objectives.
1. Internal Revenue Code Sections 2601 through 2664.
2. The recent decisions in United States v. Windsor, 133 S.Ct. 2675 (2013) and Hollingsworth v. Perry 133 S.Ct. 2652 (2013) demonstrate the ongoing developments within the institution of marriage. The impact of these decisions, however, is beyond the scope of this article.
3. “Mae West: More Than a Sex Symbol,” University of Virginia: Inside UVA Online Newsletter, www.virginia.edu/insideuva/textonlyarchive/94-11-04/4.txt (Nov. 11, 1994).
4. Paul Hood, “A Second Marriage is a Triumph of Hope Over Experience!,” LISI Estate Planning Newsletter, #1470, www.leimbergservices.com (May 28, 2009).
5. IRC Section 2642(c).
6. Estate of Kennedy v. Plan Administrator for DuPont Savings, 555 U.S. 285 (2009).
7. Employee Retirement Income Security Act Section 206(d)(3)(B)(i); IRC Section 414(p)(1)(A).
8. Estate of Kennedy, supra note 6.
9. Holmes v. Beatty, 290 S.W.3d 852 (Texas 2009).
10. Texas Estates Code Section 112.052.