Estate Planning for Blended Families

Since it began appearing in the early 1970s,¹ the term “blended families” has gone mainstream as social and cultural norms have evolved. According to one estimate, about a quarter of all marriages and nearly two-thirds (63%) of remarriages involve stepchildren.² No matter how loving and successful, such arrangements often pose unique personal and financial challenges that may only intensify as wealth transfers from one generation to the next.

For the older generation, the use of certain popular estate planning tools — the marital trust in particular — can pose problems. In addition, difficult questions can arise over how best to divide property, particularly non-financial assets such as real estate or tangible property. In the absence of wills and other estate planning documents, these decisions will be left up to courts, following a state’s intestacy laws. Intestacy laws attempt to provide a standardized mechanism for the division of property at death and are ill-equipped to capture the complexity and breadth of situations that blended families face. For these reasons, careful estate planning, while highly recommended for any family, is especially vital for blended ones. In this A Closer Look, we examine some of the most prominent challenges and potential solutions.

The Marital Deduction: Challenges and Solutions

Estate plans are, of course, deeply personal, and their specifics will depend on your situation, desires, and the composition of your blended family. Questions range from whether and how to include stepchildren to whether assets will be divided equally or in varying percentages. In many cases, one of the greatest challenges involves leaving money to a current spouse while also providing for children from a previous marriage. Among married couples of substantial wealth, it’s very common for a surviving spouse to inherit all or most of the deceased’s assets, often through a marital trust. This practice is supported by tax law, which provides an unlimited gift and estate tax marital deduction that enables spouses to leave assets to one another free from estate taxes at death. Estate tax obligations are thus delayed until the second spouse passes away and leaves money to the children.

Here’s the challenge for blended families: In order to qualify for the marital deduction, assets in a marital trust can be available only for the benefit of the surviving spouse. Naming children from a previous marriage as beneficiaries would eliminate the deduction. Especially if there’s a significant age difference between the deceased’s first and second spouses, leaving the children from the first marriage out of the trust could mean those children might receive their inheritances much later in life. This can lead to tensions, including resentment on the part of children waiting to receive their inheritance. The surviving spouse may feel that his or her financial activities are being watched by the children from the first marriage, or that those children view them as an obstacle to inheritance. Resentment may be magnified if the spouse’s primary residence is included in the trust — since the trust may be required to pay for repairs and expensive capital improvements. Discord may arise depending on who the trustee is and who gets to decide whether the improvements are warranted or excessive.

Finding solutions. These challenges, while complex, may be overcome with some advance planning. One solution that we’ve seen work well involves incorporating a life insurance policy that’s held inside an irrevocable life insurance trust (ILIT) and that designates children from a prior marriage as beneficiaries. With a well-structured ILIT, the insurance proceeds can go to the children free from estate taxes when the parent dies with the assets in the estate going to the surviving spouse. Depending on one’s desires, tax situation, and the financial needs of the children and current spouse, the opposite might work. The spouse could receive an insurance payout while the children inherit the estate assets, which would be subject to potential estate taxes (beyond the estate tax exemption amount).

Another approach might be for the parent to make lifetime gifts to their children from a prior marriage to compensate them for the years they may have to wait until the spouse from the second marriage dies. These can take the form of irrevocable trusts that use the gift and estate tax exemption. In addition, grantor retained annuity trusts (GRATs) may provide an effective means for making gifts during one’s lifetime without significant use of one’s gift tax exemption. With a GRAT, the grantor receives annual payments, typically for two years, with the remainder (to the extent the trust assets exceed the IRS “hurdle rate”) going to beneficiaries when the trust terminates. Finally, if the parent believes that the children from a prior marriage and the second spouse are already well taken care of financially without an inheritance, they may choose to use their estate to support charities, whether through the family foundation, a donor-advised fund, or individual charities.

Distributing Assets: Who Gets What?

Yet even with challenges such as the marital deduction resolved, crucial decisions remain on how best to divide specific assets. While liquid assets such as cash and marketable securities split easily into whatever proportions you deem appropriate for beneficiaries, the same cannot be said of a vacation home or art collection. Estate plans stipulating that beneficiaries share assets such as these may seem to make the planning process simpler, but instead might heighten tensions and ill will if the beneficiaries are from different marriages and don’t already have a close relationship. You may want to consider some alternatives.

Tangible personal property. Unlike liquid assets, property such as jewelry, art, boats, furniture, or vintage automobiles often has sentimental and emotional value equal to or even greater than its monetary value. While some items, such as a collection of photographs, might be reproduced for any heir who wants one, most decisions about tangible property will require careful thought as to the appropriate recipient. And keep in mind that your desires may change as your family evolves.

As a starting point, consider which items of tangible property form logical collections that ought to be handed down intact. For example, a set of family silverware may be more meaningful and valuable if left to one recipient rather than giving a few pieces to many. And you can provide for other heirs with other items. Many estate plans allow for the inclusion of a “side letter” or memorandum directing the distribution of specific items of tangible personal property to specific recipients. For example, a particular painting may be earmarked for a child or grandchild who has an affinity for that artist or depiction. Because these are ancillary documents, you can periodically revise and update them without redoing your formal estate planning documents. A related ancillary document — a letter of wishes — can also be used to help executors, trustees, and family members understand the reasons and motivations behind your decisions. (See “Sharing Your Vision and Values: Exploring Letters of Wishes.”)

For items that are too numerous or that you’re unsure how to distribute, you can help your executor or successor trustee by establishing a clear process for beneficiaries to choose the items that mean the most to them. This might include, for example, a rotating selection process or an auction-style approach where each beneficiary is given a set number of points (you determine the proportions) that can be “bid” on the personal property. Anything left after the process is complete could be sold or donated to charity.

Real estate. Held in trust, real estate investments can offer an attractive legacy for your heirs, potentially providing income, appreciation, and portfolio diversification now and for generations to come. Yet such properties require ongoing management and difficult decisions on maintenance, capital improvements, and other needs. Personal use property, such as a family homestead or cherished vacation home, presents similar challenges, with the added complexities of determining who, how, and when different beneficiaries may use the property. Emotions often come into play, as some members may feel more vested than others in keeping the property in the family. In addition, logistical considerations such as geographical distance from the property and age of children (if any) may affect family members’ enthusiasm for the use of and financial support for the property.

Especially in blended families, it’s important to carefully consider whom to include among the beneficiaries of real estate holdings. Rather than pushing step relatives into the difficult position of sharing as beneficiaries, it’s often a best practice to leave a property to one individual or group and to provide for others in different ways. For more information on real estate and your legacy, see Bessemer’s related articles “Building a Lasting Family Legacy: Holding Real Estate Investments in Trust” and “The Real Estate Legacy Challenge: Keeping Your Home in the Family.”

Choosing Trustees to Help Manage Family Dynamics

There are powerful incentives to appoint family members you love and trust implicitly to serve as trustees. Yet it may also be worth considering appointing independent trustees or co-trustees with experience in trust administration and management.

Independent trustees may have special expertise in complex assets such as real estate, described above, and may also be better able to navigate the emotional pitfalls that may come with blended families. Say, for example, you have a grown child from a previous marriage who seems like an ideal candidate to serve as trustee. She’s competent, responsible, and fully capable of managing and distributing assets. Yet even a well-founded decision to deny distribution requests from stepsiblings could be seen as biased, especially if there’s a history of contention between them. Or, out of a desire to avoid such accusations, she might have trouble saying no. An independent trustee without that stepfamily connection may be in a better position to make such necessary decisions without causing negative feelings among family members.

Opening the Lines of Communication

Any family, regardless of its composition, can have difficulty discussing financial issues and wealth. In our experience, families that get over those hurdles and communicate openly often have the smoothest wealth transfers. We have found that family meetings provide an excellent opportunity for members of various generations to speak openly about family wealth and shared values. You might arrange periodic meetings where you fill members in about your plans and give them the opportunity to share their thoughts.

For the youngest family members, covering basic financial topics can give them a grounding in the meaning and responsibilities of wealth, and instill them with the family story. As they mature, you can broach the family’s wealth plan, philanthropic legacy, and your hopes for future generations. If divisions within your blended family make it necessary, you could hold separate meetings for individual groups. You could even meet one-on-one as necessary. Whatever method works best, the key is to communicate clearly and openly to avoid misunderstandings and unpleasant surprises later on.

Seeking Advice

Creating carefully designed estate plans for your blended family may feel like a heavy task, and one you’d rather put off for another day. Yet considering life’s uncertainties, getting started now can help ensure not only that your personal wishes will be carried out when the time comes, but that it can happen with minimal disruption for those you love.

And you don’t have to go through this alone. Your Bessemer Trust client advisor can help arrange conversations with our estate planning specialists, who can walk you through best practices for distributing property, communicating with beneficiaries, and creating a plan that works for you and your blended family.