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“Blended families” � those comprising at least one spouse who has a child or children from a prior relationship � are becoming increasingly common and present a unique challenge when creating an estate plan. Structuring an estate plan that, in the event of a death, avoids exacerbating tensions between the remaining members of the family requires extra attention, but is possible. Unfortunately, the special circumstances of a blended family are too often ignored by couples with unrealistic expectations and estate planners who don’t want to force the issue with their clients. Ignoring these issues, however, can be catastrophic. Below are five specific mistakes made in this context that practitioners see over and over again: • Giving the surviving spouse too much control over the ultimate distribution of the predeceasing spouse’s property. The most egregious example of this mistake is when the first spouse to die (the predeceasing spouse) leaves the surviving spouse his or her estate outright with the informal understanding that when the surviving spouse dies, he or she will “take care” of the predeceasing spouse’s children. A more subtle example is when the predeceasing spouse creates one or more trusts for the benefit of the surviving spouse and gives the surviving spouse too much power over the remaining trust property upon the surviving spouse’s death. In such a situation, the trust language might provide that “upon the surviving spouse’s death, the surviving spouse may appoint the balance of the trust property among our children (defined as the survivor’s children and the predeceasing spouse’s children).” The obvious pitfall of both these approaches is that the children of the predeceasing spouse may end up getting nothing, which was clearly not the intent of the predeceasing spouse. Experience suggests that all too often a surviving spouse will pass property to his or her own biological children at the expense of stepchildren. Also, a surviving spouse’s motivations and attitudes may change with time, especially if there is a subsequent remarriage. Consider a hypothetical case involving a highly compensated businessman, John, and his third, much younger, wife, Lisa. John has a net worth of around $50 million. Lisa has a net worth of about $500,000. John had three teenage children by his prior marriages. He is somewhat estranged from all three children, whom he describes as “ungrateful” and bitter about his decision to leave their respective mothers. Shortly after the marriage, Lisa becomes pregnant with her first child. After learning of Lisa’s pregnancy, John and Lisa consult with an estate planner. Both parties insist that the plan be structured so that the survivor inherits the predeceasing spouse’s entire estate outright. John describes Lisa as “the love of my life” and insists he can trust her totally. He is confident that if he died first she would do the right thing with his money and give his other children what was fair. The estate planning attorney offers only mild resistance, suggesting that it might be wise to leave John’s teenage children a portion of John’s estate to discourage a contest of his estate plan and also to do some transfer tax planning. This advice is never put in writing. Eager to prove his love for his young wife, John scoffs at the estate planning attorney’s advice, and the plan is drawn up in the “everything outright to my spouse” format. When John dies suddenly of a heart attack two years later, his children by his prior marriages contest his estate plan, resulting in years of litigation and aggravation for everyone, especially Lisa. Lisa in turn sues the estate planning attorney for not adequately highlighting the risks and tax-planning deficiencies associated with the estate plan. Unfortunately, the estate planning lawyer has no documentary evidence that he had properly counseled the couple. Draft appropriate estate plans A better way for John to have planned would have been for him to have taken appropriate responsibility for his children by prior relationships (however “ungrateful” he felt they were) and to have identified what, in fairness, they should have ultimately received. He then should have drafted an appropriate estate plan. What would this plan look like? John should probably have provided for significant cash gifts (in trust) to his children at the time of his death (probably in the amount of the estate tax exemption, currently $2 million, plus life insurance) and additional gifts after the death of Lisa. Meanwhile, the portion of John’s estate going to Lisa should have been held in a marital trust for her benefit, and Lisa should not have been given the power to alter the gifts going to John’s children from prior marriages. The estate planning lawyer should have advised John in writing that if he did not plan for his teenage children properly, there would almost certainly be a contest upon his death that would be expensive and cause Lisa more heartburn than John’s decision to properly provide for all of his children. It would have been difficult for John not to have taken this advice, and he probably would have put a plan in place for his teenage children that they would have been far less likely to contest. • Designating a stepparent and a stepchild to act together as co-fiduciaries. In this situation the predeceasing spouse establishes an estate plan that provides that, upon his or her death, the surviving spouse and the predeceasing spouse’s children are to act together as trustees of the predeceasing spouse’s living trust. The estate plan further provides that, upon the predeceasing spouse’s death, one or more trusts, comprising all of the predeceasing spouse’s property, are to be established for the benefit of the surviving spouse. The surviving spouse is entitled to all trust net income but may only invade trust principal for health or support. Let’s assume the income from the trust is not enough to support the surviving spouse in his or her accustomed manner of living and that the surviving spouse has limited personal funds. Now he or she is thrust into the position of having to convince a stepchild, who presumably stands to inherit the trust property on the surviving spouse’s death, that the surviving spouse needs to invade principal. This is almost sure to cause tension and disagreement. Another related issue arises in the context of characterizing money received by the trust as income or principal (a critical distinction when the surviving spouse is entitled to all trust net income, but not trust principal). This analysis has become subtle and complex in recent years with the passage of the Uniform Principal and Income Act, and there is potentially a lot to argue about in applying these complicated and arbitrary rules. An example of this mistake can be found in the hypothetical story of Susan and Peter. Susan, the wealthier spouse, dies and leaves her estate in one or more trusts for the benefit of her surviving spouse, Peter. Susan earned a large salary as an investment banker, which is now gone, and most of her other wealth is tied up in illiquid partnership investments. Peter is retired and has a small pension, but the couple lived on Susan’s salary. Peter is designated to act as a co-trustee of the trusts for his benefit with Susan’s son, David. Peter and Susan were married after David had grown up, and while Susan thought the relationship between Peter and David was good, in reality it was superficial. Peter soon feels he needs to invade principal to live in the manner he is used to, and David resists. A lengthy court battle follows. Designate a neutral third party Susan’s estate plan should not have put her family members into situations where they were likely to disagree and end up as adversaries. In this case she should have considered designating a neutral third party, such as trust company or bank, to act as trustee of the trust or trusts for Peter. • Not thinking through the terms of a marital trust. Estate practitioners often see marital trust provisions with generic terms that provide that the surviving spouse “is entitled to all trust income and to trust principal as needed for health and support.” The only additional guidance given is a directive that the trustee “is to take into account the surviving spouse’s other resources” in making its decision as to whether to distribute any principal. The hypothetical of Susan and Peter is again illustrative. Susan was wealthy and Peter was not. And Susan paid for a lifestyle that far exceeded any income from her investment property or from Peter’s property. If Susan had designated Peter as sole trustee, he could have invaded the principal, but there would have been a risk that David would object in his capacity as the ultimate beneficiary of the trust. As discussed above, having Peter and David act together as co-trustees did not work well. Even if Susan had designated a third party to act as trustee, Peter would have been required to make the case that he had a bona fide need to invade principal, a tedious process at best. Instead, Susan should have provided that Peter was entitled to all income and that distributions of principal should be made to him to supplement income in an amount that, when added to the trust income, approximated amounts paid by Susan when she was alive to cover communal living expenses in the two or three years preceding her death, adjusted for inflation. This directive may have allowed Peter to continue living in his accustomed manner of living without undue interference or stress. • Failure to consider appropriate allocation of estate taxes upon the death of the surviving spouse. A typical marital trust is taxed in the estate of the surviving spouse along with the surviving spouse’s own property upon the surviving spouse’s death. Often spouses fail to properly plan for the equitable allocation of estate tax on the surviving spouse’s death such that one spouse’s children are paying more than their fair share of estate tax. This blunder is another immediate recipe for tension, this time between former stepsiblings. The hypothetical here is that of Allan, who actually makes some effort to keep his promise to his predeceased spouse, Helen, and leaves the residue of his estate in three equal shares to his two children and Helen’s child from a prior marriage. The one exception is Allan’s tangible personal property, which includes an art collection he had inherited years before from his own parents. This he specifically devises to his two children. It turns out that, unbeknownst to Allan, these works of art have appreciated hugely and are now worth several million dollars. Meanwhile, Allan’s estate plan provides that estate taxes are to be paid by the “residue” after distribution of the tangibles (this is typical “boilerplate” language). Thus, Helen’s child effectively bears one-third of the estate tax on assets that pass to stepsiblings. Even worse, there is not much residue left after the payment of all of the estate taxes. The stepchild ends up inheriting a one-third share of not much but sour grapes. Litigation ensues. Allan should have at least considered providing that estate taxes attributable to the property of his estate were to be equitably apportioned. Couples and surviving spouses should actively plan for this issue together rather than ignoring the problem and allowing it to surface later as an unwanted surprise for their children. • Making descendants wait until they are senior citizens to inherit from their parent. Another common mistake is delaying children’s inheritances for many years after a parent’s death. A scenario estate practitioners see often is one in which the predeceasing spouse, who was 10 years older (65) than the surviving spouse (55), leaves property in trust for the benefit of the surviving spouse. Given the surviving spouse’s actuarial life expectancy, if the predeceasing spouse’s children are in their early to mid-thirties, they may have to wait until they are in their mid-sixties or older to inherit any money from their parent. Obviously, this issue can create a lot of tension between the surviving stepparent and the stepchildren and further fuel the tensions discussed above. The solution, if it is financially feasible, is to provide for an immediate gift to the predeceasing spouse’s children upon the death of the predeceasing spouse. Under current law, up to $2 million may be distributed free of estate tax to children upon the death of the predeceasing spouse. Also, a parent should consider using life insurance, or other strategies, to pass wealth to children sooner rather than later. None of the solutions described above is difficult to incorporate into an estate plan, and each will go a long way toward preserving good will among blended family members upon the death of the predeceasing spouse and afterward. William P. Fuller is a partner at San Francisco-based Howard Rice Nemerovski Canady Falk & Rabkin, where he specializes in estate planning. He can be reached at [email protected]. The hypotheticals are loosely based on real-life scenarios.

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