My Children, Your Children, Our Children: Estate Planning for the Confused Family

Estate planning examples for the typical family always seem to have the same facts.Ward has been married to June for 16 years. They have two perfect children, Walter, age 12, and Theodore, age 10. Best of all, everyone lives happily ever after. The goals are always the same: to protect the spouse first, to provide for the children’s education second, and to save death taxes, if applicable. Absent death tax concerns, estate planning is easy. Ward and June leave everything to one another. They create a trust in their wills for their minor children if they are both deceased. The children grow up to become responsible adults and properly manage their inheritance.  

In the real world, we often find that things do not work out the way they should.  Ward and June divorced years ago. June has custody of the children, and her relationship with Ward is, at best, strained. Ward does not always do the things he should do as a parent. He remarried and the financial demands of his new marriage, child support obligations to June and financial obligations to support his new child produce continuous financial strain.  Unfortunately, this family situation has become the norm in America.

But there is life after divorce. June met and married Jack, who has two children of his own by his first marriage. He pays child support, too. June and Jack have typical middle-class assets: a home with a mortgage, two cars with a note, various adult toys and large balances on their credit cards.  Even in the best of times, June and Jack do little more than pay the bills and put a few dollars away for the children’s education.

To make matters worse, June and Jack created yet another problem. Angela was born last year, and now June and Jack have added “our” child to the “my” children and “your” children family dynamics. The relationship between Jack and June is good, but their relationship with their respective stepchildren is one of tolerance rather than love.  The passage of time may cure this problem—and someday it may be one family—but, for now, it is still a “your” children and a “my” children family.

Estate planning concerns of Jack and June are monumental. Because they consolidated their assets when they married, everything is held jointly with right of survivorship. There are few assets in either spouse’s separate name. Life insurance and employment benefits are payable to the spouse. Jack and June agree that their primary obligation is to one another. However, each parent acknowledges an obligation to both the children and the step-children. There are just not enough assets to go around. You might say that June and Jack do not have an estate plan, but they do. Jack and June have created a dying contest: not only does the first spouse to die lose, but the children of the first spouse to die will likely also lose.

June and Jack reluctantly recognize that the children from their first marriages will likely receive nothing at the death of the parent if the other is surviving. However, they “agree” that at the death of both of them, the five children will share equally. They execute reciprocal wills leaving everything to one another; in the event of the death of both of them, all assets will pass into a trust for the five children. They may even buy some life insurance to help the surviving spouse upon death. We have arrived at Utopia.  The estate planning is concluded and the problems are now gone.  Or are they?  

What Jack and June each fail to realize is that their spouse’s relationship with the stepchildren will, for all practical purposes, likely end at death. The spouse and the step-children will likely grow apart. In fact, the stepchildren will ultimately realize, either with or without their surviving natural parent’s help, that their parent died and left them nothing.  Rather, the parent left everything to the new spouse.

The result is conflict and controversy, legal or otherwise, among the spouse and the children from the prior marriage or among the spouse and the step-children’s surviving parent. All chances that the “family” had of maintaining a relationship disappear, and hostility often breaks out.

After Jack’s death, June recognizes that Jack’s children have a mother to take care of them and that she, with a little help from Ward, must take care of her own children, including Angela.  June rationalizes that it would be improper for her to leave any of her estate to Jack’s children. She knows that Jack would understand. After all, he did leave June all of the assets, didn’t he? June’s will is changed shortly after Jack’s funeral, leaving all assets to her children and effectively destroying the couple’s estate plan and disinheriting Jack’s children by prior marriage.

This story has been played out far too many times. Fortunately, the problem has solutions and, best of all, they are simple solutions if we merely address each individual problem as a separate estate planning concern.

First, let’s look at Jack and his problems. Remember, everything we do applies equally to June, too. Jack has two children by a first marriage, two stepchildren, and a child by his second marriage. Jack owes duties and obligations to his wife and his children.  Although he has no obligations to his step-children, he owes them the gift of leaving their mother in financial comfort.

Jack needs to separately provide for his children by his first marriage. At his death, if June is surviving, at least a minimum amount should be set aside by Jack for his children. If they never receive another dollar, Jack can say that he has made adequate provisions for his children; thus, if June subsequently changes her will to cut out Jack’s children, they will still have received a minimum distribution to provide for their health, support and education.  

What assets should he take away from June and give to the children? The answer is nothing. Life insurance is the best—if not the only—logical solution.  If Jack’s children are beneficiaries of life insurance, June can receive all of the assets owned by Jack and June at Jack’s death. Nothing has to be sold or divided or taken from June to protect Jack’s children. But how do we give it to them?  Do we give it to their mother or do we just make it payable to the children and let the court determine through guardianship proceedings how to handle it? One way is to establish a Revocable Inter Vivos Life Insurance Trust. The trust is established solely for the benefit of Jack’s children from his first marriage and is the beneficiary of life insurance on Jack’s life.

The trust is designed to provide for the health, support and education of Jack's children by the first marriage. The trust also can provide the support payments that Jack would have made had he been alive by authorizing the trustee to make payments directly to the mother of the children to assist in their support. To make sure that the support does not become the sole source of the children’s support, the trustee can be prohibited from using trust funds to discharge the surviving natural parent’s support obligations. Their mother must do her share, too.

The trustee can hold and administer the trust assets for the benefit of the children until they complete their education and perhaps reach an age of maturity, such as 30. Then, the balance of the trust can be distributed outright to them. In the alternative, the trust actually can be held for the children for life, protecting the assets from creditors of the children and/or their future divorces.

By using a Revocable Insurance Trust, we get the best of all worlds. Jack’s children are properly taken care of without hurting June and Angela.

In summary, Jack and June create Revocable Living Trusts funded with life insurance for their respective children by their prior marriages.  They may be similar in many ways, but they can address individual needs of the two very different families.  The estate plan becomes easier. Assets can be held jointly with right of survivorship. Other assets can be payable to the spouse by beneficiary designation. The spouse can receive the entire estate except for the insurance payable to the trust. The husband and wife can then write their wills, leaving everything to one another and set up a trust for “our” child in the wills if both spouses are deceased. They can instruct that the balance of the estate not specifically directed by beneficiary designations be divided in a predetermined way to meet the different needs of the various children. Provisions for each spouse’s separate children can be made by directing assets directly to the trusts that have already been created.  

In short, using life insurance and Revocable Life Insurance Trusts in this family situation assures that everyone is provided for and that no one is accidentally cut out.