A Closer Look:
Estate Planning in a Blended Family
A scenario illustrated through the popular television show “Modern Family.”
One of the most important situations where thoughtful estate planning is needed is in a blended family, where spouses are on their second marriage and have children from previous relationships. Often, people enter a second marriage with estate planning that was done during the prior marriage and never updated – or with only a simple will that leaves everything to their current spouse.
As a result, they may mistakenly believe that leaving everything to their surviving spouse will ensure all children are treated fairly. This assumption could be disastrous. The surviving spouse who inherits all marital assets has the ability to leave all property to their kids alone, thereby disinheriting the first spouse’s children and potentially leading to major family acrimony, strained relationships and potential litigation.
To explore how these challenges play out in real life, we’ll examine a blended family scenario inspired by the characters of “Modern Family.”
Balancing a Spouse’s Needs With Children From a Prior Marriage
Here’s the scenario: Jay and Gloria are on their second marriage. Jay is much older than Gloria and has two adult children from his previous marriage – Mitchell and Claire. Gloria has a younger son named Manny from her previous marriage. Jay’s intent is to make sure Gloria and Manny are taken care of when he passes away while still leaving assets for his adult children. What are his options to accomplish this goal?
How a QTIP Trust Helps Carry Out Long-Term Wishes
Establishing a trust is the best estate planning tool for Jay to leverage in this situation. There is a certain type of trust that would be most appropriate for this situation called a qualified terminable interest property trust (QTIP). A QTIP trust is a type of marital trust which allows a person (the grantor) to leave property for a surviving spouse during their life, while maintaining control over how assets ultimately pass to the remainder beneficiaries. It’s typically created through a will or a revocable trust. The QTIP is normally funded when the grantor spouse passes away.
This trust also offers key tax benefits. A QTIP trust qualifies for the unlimited marital deduction, which means assets placed in the trust are not subject to federal estate tax when the first spouse dies. Use of this trust doesn’t eliminate the tax, though. Instead, estate tax is deferred until the surviving spouse passes away – the same way it would be if the deceased spouse left assets outright to their surviving spouse. In other words, a QTIP trust achieves the same favorable tax treatment as a direct gift to a spouse. The difference is that, in a blended family scenario, a QTIP trust allows those benefits to be paired with added estate planning control – making it a more effective option than an outright gift in most cases. When drafted to meet the legal requirements delineated in the internal revenue code, the QTIP trust is unique in its ability to combine both benefits.
What Can Happen Without an Updated Plan
In a worst-case scenario, Jay could fail to update his estate planning documents after his marriage to Gloria, be diagnosed with an unexpected illness and ultimately pass away. At that point, Jay’s estate would likely end up in probate court.
Probate means a court is responsible for supervising the administration of a deceased person’s assets and how they should be distributed. The court will appoint an executor to administer the estate according to the decedent’s will or state law. Probate can be a long, costly process for family members. In some states, it may take a year or more for the court to appoint an executor and open the estate. Importantly, probate can delay family members from inheriting for years. There is also the cost of hiring an attorney to assist in the administration, which can become expensive.
A major benefit of having a trust is that all property titled in the name of the trust prior to the trust grantor’s death avoids probate. In our scenario, though, Jay failed to open a trust – so his assets will have to go through the process. There will likely be fighting amongst his family members on who should inherit certain property since Jay’s estate plan wasn’t updated, which could cause hurt feelings and family estrangement. Jay’s wishes will not be fulfilled, and his family will suffer harm – an outcome that should and can be prevented.
There are several requirements to create a QTIP trust and qualify for the marital deduction. The requirements are:
- The surviving spouse must receive all income from the trust property at least annually
- No person other than the spouse can be a beneficiary of the QTIP trust during the surviving spouse’s lifetime
- The trust must state that the grantor’s spouse may at any time, by written notice, require the trustee to make any non–income producing assets into income-producing assets
- The QTIP trust must be irrevocable after the first spouse’s death
Choosing a Trustee in a Blended Family
The next key question is who should be named as trustee of the trust. The trustee is responsible for implementing the terms of the trust, managing and investing the trust assets and making distributions to beneficiaries. A trustee is a fiduciary, and is required to act in the best interest of the beneficiaries – exercising a duty of loyalty, care and disclosure. In the blended family, it’s incredibly important to have an unbiased and professional trustee.
Let’s go back to our scenario: Jay establishes a QTIP trust for Gloria and names his son, Mitchell, as the trustee. Does Gloria really want to be asking her stepson for distributions? Mitchell also has the incentive not to make distributions to Gloria, because he inherits from the trust after she passes away. This dynamic has enormous potential for conflict and possible litigation.
What if Jay named Gloria as the trustee of the QTIP trust? Since a QTIP trust requires the income of the trust to be distributed annually to the surviving spouse, Gloria acting as trustee may choose to make investments that will generate a larger amount of trust income. However, Jay’s children (who are the ultimate QTIP trust beneficiaries at Gloria’s death) may prefer that the Gloria make investments that will preserve or grow the trust principal. By naming Gloria as the trustee, Jay has placed his spouse in the precarious position of possibly breaching her duty of loyalty to the trust’s future beneficiaries.
Taken together, these scenarios highlight why naming a family member as the sole trustee can create tension in a blended family. That’s where a professional fiduciary or trust company – like Baird Trust – can serve as the sole trustee or co-trustee, whose responsibility is to administer the trust according to its terms. As a neutral third party, a professional fiduciary allows family members to avoid awkward dynamics. In this situation, a professional trustee can balance the needs of Gloria with the interests of Mitchell and Claire, making decisions that support everyone involved.
The blended family can be one of the most complicated scenarios for estate planning, and is filled with potential pitfalls that thoughtful estate planning can help avoid. Rather than failing to update estate planning documents, making outright gifts to spouses and hoping the surviving spouse provides property equally to all family members, the QTIP trust provides a solution: giving the grantor control over the ultimate beneficiaries while providing for the spouse while they are living. This trust also provides tax benefits of the marital deduction for all transfers to the trust.
Want to learn more about how Baird Trust can support estate planning for your blended family? Reach out to your Baird Financial Advisor or contact Baird Trust.
Baird Trust Company (“Baird Trust”), a Kentucky state chartered trust company, is owned by Baird Financial Corporation (“BFC”). It is affiliated with Robert W. Baird & Co. Incorporated (“Baird”), (an SEC-registered broker-dealer and investment advisor), and other operating businesses owned by BFC. The information offered is provided to you for informational purposes only. Neither Baird nor Baird Trust is a legal or tax services provider and you are strongly encouraged to seek the advice of the appropriate professional advisors before taking any action. The information reflected on this page is subject to change. The information provided here has not taken into consideration the investment goals or needs of any specific investor. Investors should not make any investment decisions based solely on this information. Past performance is not a guarantee of future results. All investments have some level of risk, and investors have different time horizons, goals and risk tolerances, so speak to your Baird Financial Advisor or a member of your Baird Trust team before taking action.
