Estate Planning for Blended Families

The process of settling an estate can be difficult for many families. Hurt feelings, disagreements and conflict over who's in charge are common issues. But for blended families—who now make up 21% of opposite-sex couples, according to the US Census Bureau—it may be even more challenging.

When one or both spouses have children from a previous partner, a lack of thorough estate planning can do more than just muddle the process of deciding who gets what after a parent passes away. In some cases, it may result in unintended and potentially serious outcomes.

Blended families' inheritance issues

It's common for married people to pass most of their assets along to their surviving partner—and in the absence of an estate plan, this may happen automatically, particularly in states with community property laws. In a blended family, this may leave the deceased parent's children from a prior marriage feeling rejected, angry or confused, leading to bitterness all around.

Other serious consequences may also arise. What if the surviving spouse makes poor financial decisions that deplete the estate's value, leaving nothing for the deceased spouse's children? What if the surviving spouse remarries or decides to leave everything to their own biological children?

Ultimately, if one partner hasn't updated their estate plan in years—and fails to do so after remarrying—their original plans may not align with their most recent wishes.

Estate planning tips for blended families

Estate planning involves more than just allocating money and assets. No matter your circumstances, it's important to establish some basic estate planning documents—including a living will, healthcare power of attorney and durable power of attorney for your finances.

Think carefully when choosing a power of attorney. People often name a spouse to act on their behalf in these matters, but in blended families, this could lead to conflict about who's in charge, particularly when it comes to health-related decisions.

The same caveat applies to choosing an executor for your will. Don't automatically assume this should be your spouse or eldest child.

Michael Deming, JD , CFP®, CEPA™, Senior Vice President, Director, High Net Worth Wealth Planning at First Citizens, compares serving as an executor in a blended family to representing yourself in court, adding, "When it comes time to act, you might think, 'What have I gotten myself into?'"

Trusts for blended families

Setting up a trust may be a way to avoid, or at least minimize, problems that often arise when dividing assets in a blended family. Two types of trusts are particularly well-suited for blended family estate planning—a qualified terminable interest property trust, or QTIP trust, and an AB trust.

QTIP trust

A QTIP trust may help ensure everyone is treated fairly, as this type of trust provides shelter from estate taxes while also providing for the surviving partner. With a QTIP, the living spouse is the primary beneficiary during their lifetime, and as such, they're entitled to income generated by the trust assets. However, the grantor may designate beneficiaries to inherit the trust's assets after the living partner's death.

"QTIPs give you the ability to benefit your spouse during their life and then make sure your own children benefit from the money that you've built once your spouse passes," says Tammie Yarter, AFTA, Vice President and Senior Fiduciary Services Officer at First Citizens.

She notes that QTIPs are a popular strategy with entrepreneurs hoping to gift ownership shares in a family business.

AB trust

Another helpful strategy for blended family estate planning is an AB trust, also called a bypass trust. With an AB trust, one or both spouses establish two separate trusts that will be funded when the first spouse dies. Trust A is a revocable trust that holds the surviving spouse's assets, while an irrevocable trust, trust B, holds the deceased spouse's assets.

Generally, the surviving spouse—or a corporate trustee—is the trustee for both trusts during their lifetime, with access to income and benefits from both. However, the surviving spouse may not change the beneficiaries of trust B, and those assets will transfer upon that spouse's death.

While both QTIPs and AB trusts help you provide for your children and a surviving spouse, AB trusts offer a bit more control for the surviving spouse. By setting up a separate revocable trust in their name, they gain control over a share of the marital assets. Meanwhile, the irrevocable trust B protects the deceased spouse's heirs.

Other trusts for blended families

Other types of trusts may help you achieve more varied financial goals—such as donating to charity, providing for a loved one with special needs or controlling how heirs spend their inheritances. It's helpful to speak with a financial professional about your reasons for establishing any type of trust. They can help you evaluate the benefits of a trust and determine which type will best meet your needs.

Life insurance and other options

Life insurance may also be a way to provide for children from a previous marriage. Designating those children as the beneficiaries of a life insurance policy may free up other assets, enabling you to leave most of your money and property to your spouse. And it may be especially helpful if your second spouse is much younger than you—possibly preventing your children from waiting many years to receive an inheritance.

Life insurance can be a simple solution that doesn't involve a trust. However, you may also establish an irrevocable life insurance trust, or ILIT, to hold a policy or policies. At your death, the trust will collect the death benefit and distribute it according to the terms set in the trust document. And because the ILIT owns and controls any policies, the value of the death benefits isn't included in your estate.

You may also designate specific beneficiaries for bank accounts, such as personal checking or savings accounts, individual retirement accounts, or 401(k) plan accounts. Note that spouses and minor children generally have more flexibility than adult children when inheriting retirement savings. It's important to speak with a financial professional in all cases to make sure you understand the rules, and it may lessen the chance your heirs will be stuck with an unexpected tax bill.

The importance of communication

While estate planning may be a difficult topic to broach, it's essential for everyone to have open and honest conversations about their plans—and even more so in a blended family.

Speaking with your spouse about your wishes can be an important first step. "It's so important to understand the complexities of a couple's feelings toward all their children," Yarter says. "One of the biggest challenges in estate planning for blended families is understanding these extremely specific relationships. And each partner might not feel the same way."

Finally, let everyone know about your wishes in advance. Having ongoing conversations with your children about your plans may help mitigate any confusion, resentment and hurt feelings after your passing.

The bottom line

Trusts can be a helpful part of blended family estate planning, but they don't have to be the only tool in your toolbox. There are a range of financial and legal strategies for distributing your assets and managing your affairs that may help avoid bitterness or strained family relationships after you pass away.

Working with a trusted wealth consultant may make it a bit easier to explore these options.

"At First Citizens, we have access to estate settlement professionals, insurance professionals and even personal trust officers," Yarter says. "We'll talk to you about different strategies and bring in the team members as needed."