One of the biggest challenges in personal finance is dealing with estate planning. I find that to be true in my financial advice business and in the personal finance blogging space. We see numerous posts that talk about saving, spending, managing debt, and investing. That's as it should be. These principles are the foundation of personal finance.
Estate planning is a subject that gets pushed to the back burner. And don't think that applies only to Millennials and the Gen X generations. Of course, they are more likely to put off this kind of planning due to their age. That's a mistake. I'll talk more about that in a minute.
You might think that as we age, estate planning would move more to the forefront of our planning. I can assure that in my experience, that isn't the case. There is a common denominator that crosses every decision to avoid, or at the very least, put off estate planning.
The Taboo Topic
We are not comfortable dealing with our own mortality. We don't want to think or talk about it. I get that to some degree.
Of course, you know the problem with this mindset, right? No one gets out of here alive. There are no exceptions to this rule.
You've planned how to spend, save, and invest your money. You've planned for your retirement, the first home, college education for your kids, marriage, and many other things in life. Planning what happens with your property after you're no longer here to enjoy it is an equally important step.
If you're in a second marriage (or more), that kind of planning is even more important. And that's the topic of today's discussion. Second marriages bring a layer of complexity to your planning, especially if there are children involved.
We will start with the basics and move into the specifics of estate planning for those in second marriages.
What is Estate Planning?
In its basic form, a properly designed estate plan sets up the process of distributing your property to those you want to receive it upon your death. Having this “instruction manual” in place assures your assets get where you want them to go in the form you want them to receive them (i.e., all at once, over time, in cash, in kind, etc.).
It sets up an orderly transfer of assets to your heirs. It takes the burden of those decisions off of your loved ones. They shouldn't have to figure out what you wanted to be done with your stuff. Without a will or other type of estate plan in place, your state will decide what happens to your property. I don't know about you, but I don't want my state deciding that for my family.
In a previous post, I wrote about why everyone needs an estate plan. In it, I described the four basic documents one needs for an estate plan as follows:
- The will
- A durable power of attorney
- A durable health care power of attorney
- A living will (advance directive)
If you have a trust-based estate plan, the fifth document required is a living trust. Lots of advisors recommend a trust-based plan. In essence, your assets get retitled into the name of your revocable living trust to avoid probate. The trustees (if married, each spouse) carry out your wishes as defined in the trust document.
There are pros and cons of any estate plan.
Estate planning for First Marriages
Before talking about estate planning for second marriages, let's set the foundation of planning for those couples who stay together.
Typically, in first marriages, estate planning is pretty straightforward. The spouses want to leave their property to each other. After they're both gone, they leave the balance to the kids. There are always exceptions to the rule but that's the most common scenario.
The two most common ways to leave assets to your beneficiaries are through a will or a revocable living trust. A will can be thought of a written instruction to a probate judge, yes if you have a will your estate will still go to probate.
In fact, probate is the process that transfers a deceased owners’ assets to the beneficiaries. So, unless you have done additional estate planning a will has to be probated to transfer your assets to your children or other beneficiaries.
A living trust is typically set up to avoid the need for your estate to be probated upon your passing. However, for a trust to serve its intended purpose of avoiding probate it must be properly set up and funded.
Funding the trust
Funding the trust means retitling your assets into the name of the trust. Surprisingly, each year many trusts end up going through probate. The most cited reason for trusts going into probate is they were not funded properly or were not set up correctly
As with most things dealing with the law, the rules and regulations can be complicated and there are a lot of ways to get it wrong. You should seek knowledgeable legal counsel when planning your estate.
In other words, don’t let price be your only consideration. I recall a cartoon I saw in the Sunday paper so time ago, it was a picture of a yard sale, and a woman was selling a parachute. The caption read: “cheap, used once, never opened.”
Even the rich and powerful make mistakes with their estate planning. You do not want to end up like comic book legend Stan Lee, actress Anna Nicole Smith, or musician Prince. You only get one opportunity to get your estate planning right, seek knowledgeable counsel.
Testamentary vs. living trust
Occasionally, I meet clients who mistake a testamentary trust in a will with a revocable living trust. It is important that you understand the difference between the two documents.
In a testamentary trust, you are effectively creating a living trust up after you pass away. You are paying the probate court and attorneys to set up a trust upon death, that you could establish, today, while you are alive at a much lower overall cost.
If your goal is to control the distribution of assets to your beneficiaries or avoid probate, a revocable living trust is a good choice. of some of the more advanced estate planning documents, like intentionally defective trusts, irrevocable trusts, ILIT’s and more.
These documents are beyond the scope of this post. However, if you need help sorting out the alphabet soup of estate planning documents reach out here for a quick chat about your goals.
Distributions to Kids
I have worked in financial services long enough that I know how adult children act toward their parents and siblings when their parents are alive. It is not necessarily predictive of how they will behave when you pass.
Let’s not pick on your children, but maybe the children of your neighbors or extended family. Have you ever seen a death cause a family to fight and bicker? I know I have.
Dividing and distributing money to the kids is often one of the more contentious aspects of estate planning. If the financially irresponsible child sees his siblings get their money outright and he/she has restrictions, that can cause problems. The way money gets distributed should also be carefully considered.
One common practice is to give say 50% of the inheritance with the child reaches age 25 and the balance when they reach age 30. I've also seen distributions tied to reaching certain milestones. One might be to get half when they get their undergraduate degree and the other half when they get an advanced degree.
Property left via the will can be challenged. In fact, most states required distributions not be made until after a public announcement of the will and a six-month period to allow anyone to contest (challenge) the will.
The best way to avoid challenges to your wishes is to do careful planning up front. Equally important but often overlooked is to communicate your wishes to family members. Surprises after death can lead to conflict and unwanted costs to challenge and defend the will.
Let your wishes be known and work out any conflict before it happens.
What are the added estate planning issues for those in second (or more) marriages? Let's start with property each of the parties brings into the marriage.
Do you view that property as jointly owned when it comes into the marriage? Or do you want to separate that property? Does the blended family involve children from either or both spouses? Are the children married? Do they have kids of their own? If divorced, is your ex-spouse the beneficiary of your IRAs, retirement accounts and life insurance? What does the divorce agreement say about ongoing support for or from your ex-spouse?
Not only will you deal with the relational aspects of bringing two families together, but you'll also need to make decisions about the property you each bring and the property you acquired together during your marriage.
Where's the best place to start?
The Low Hanging Fruits
The easiest things to change are your beneficiary designations. First, decide who you want to receive this money. Because these assets pass via a beneficiary designation, they go directly to the person named. They do not go through probate.
Let me be crystal clear on this important point. If your will or trust says your life insurance, IRA, or 401(k) is supposed to go to your new spouse, but your beneficiary designation still names your previous spouse as the beneficiary, then guess who’s going to get the money?
Your previous spouse!!!!
I know it may sound like the plot of an episode of Desperate House Wives, remember the episode where Karen kept her deceased husband in the freezer so she could keep collecting his pension. They were married 25 years and he forgot to update the beneficiary at work (OK, that's a stretch, but you get the point).
However, we constantly see in the news tales of estate planning gone bad, and loved ones unintentionally being disinherited.
Tip: We live in a digital world and the downside to digital data is information can get lost. Make sure you keep a psychical copy of all your beneficiary forms with your estate planning documents. We have seen instances of online companies losing beneficiary data.
Divorce and Estate Planning
You must take special care when setting up your estate planning post-divorce. Your separation agreement may specify that your previous spouse is named the irrevocable beneficiary on your accounts. Or it may mandate that you make certain provisions in your planning regarding the support and maintenance of your ex-spouse and children.
You should discuss the terms of your separation with a qualified estate planning or elder law attorney, who among other concerns, will make sure you comply with the separation agreement.
Thinking of changing your life insurance post-divorce? Don’t be rash, the court may have something to say about it. As we mentioned earlier, your separation agreement likely dictates how you may structure your beneficiary forms.
If you have children and divorce, the court wants to make sure that money is in place to care for the kids. The includes paying for their basic needs and things like a college education. In many cases, the court may mandate that one or the other parent carry life insurance to provide the money for a college education if the parent dies before fully funding that education. If that's the case, they will dictate who pays for the policy and who the beneficiaries are.
In many cases, those needs get addressed with other sources of funds. If so, the owner of the life insurance policy can name their own beneficiary. That offers flexibility in planning for a second marriage.
If the policy owner has cash value, the court may look at that as a separate asset and divide it accordingly. They may also not take into account the cash value and look at who continues to pay the premium and how the money will be used. This may include direction over who is named the beneficiary. Courts are often more sensitive to the spouse who cannot take care of themselves financially and will rely on, to some extent, the assets and income of the ex-spouse. Requiring insurance to be maintained for that reason may be part of the settlement.
Tip: We commonly see clients with multiple children who will name one child as beneficiary on the forms out of convenience, in hopes they will distribute the money to their siblings evenly. You can avoid a lot of potential problems and heartache by taking the extra effort to specify each intended beneficiary on the forms.
Second Marriages with Kids
Second marriages that bring kids from one or both spouses require additional planning. One issue everyone who finds themselves in this situation struggles with is this – how do I take care of my new spouse and my biological children.
The best solution is usually via trusts. The question then becomes “what kind of trusts?” Here are three types of trust to consider for second marriages.
- Revocable living trusts
- Qualified Terminal Interest Property Trust (QTIP)
- Irrevocable Life Insurance Trusts (ILIT)
I know this sounds like a lot (and it is). However, in a second marriage that involves kids from one or both spouses, if you want to do it right, you're going to need to spend a little money. Trust-based estate plans are the cleanest, most effective way to take care of your family.
Let me set the stage for you.
Don’t Unintentionally Disinherit Your Children
Blending families and finances can be difficult. Ideally, it would work out like the Brady Bunch. However, that is seldom the case. Comingling assets can be tricky due to joint tenancy laws.
What may start out innocent enough could disinherit your beneficiaries. Items held in joint tenancy (as is common on most deed’s for real estate), become the property of the remaining tenants upon the death of the owner.
Imagine for a second that you remarry, and you purchase a home with your spouse jointly. You then write in your will that when you pass, your share of the home is supposed to go to your children from your first marriage.
Who do you think would receive the share of the home upon your death?
The correct answer is….. your new spouse! Since the home was owned jointly, upon your death it becomes the sole property of your spouse. Similar to beneficiary designations, property held joint passes on to the other tenants without probate.
If your spouse has specified in his/her will that the all of their belongings go their child, your children could be unintentionally disinherited. What I described above is just one of the many mistakes we routinely see blended families make when comingling assets.
I hope I've convinced you to take the need for proper estate planning seriously. I hope I've disturbed you enough to motivate you to action. Whether you're single, married once, or on your second or third marriage, don't wait to put in place a good estate plan.
And please, for goodness sake.
Don't try to take the cheap way out and do some online will or trust. Use Google for research. Become as knowledgeable as you can about estate planning. If you're thinking about doing this on the cheap, let me ask you a question. Who will walk your surviving spouses through the process of closing out your estate? Will someone on the other side of the country who you've never met and who knows nothing about you and your family do a good job of that? I think you know that answer to that.
It's about competency and relationship
Like other professionals, it's important to find someone who is specialized, knowledgeable, experienced, and in whom you have a great deal of trust. Be sure you and your spouse are both comfortable working with this individual. Your spouse and children will be knee deep in grief over losing you. Why would you want to put additional stress on them by not having a proper plan in place? Or by forcing them to work with someone they have never met and with whom they have no relationship.
I say all of the time that personal finance is about much more than just money. That goes for estate planning as much as anything else. Maybe even more. Dealing with the loss of a loved one is hard enough. Don't leave them hanging without a plan or with a discount plan and no person attached to it.
I made the offer earlier and will repeat it here. If you'd like to talk about how to get started or have me review what you're currently doing, contact me here to set up a no-obligation call.
Now it's your turn. What have you done to plan your estate?