Estate Planning for Blended Families: Pitfalls and Solutions

If your family includes children from multiple relationships, you absolutely require specialized estate planning. (See also the webinar on this same topic)

by Attorneys James L. Cunningham and Tasha Jahn of CunninghamLegal

Estate Planning for Blended Families Pitfalls and Solutions

Complex families require sophisticated estate planning.

One of the many vital complications to consider in estate planning is a “blended family.” This term is applied to families where people have remarried and have children from previous relationships.

Lots of people entering into a blended family already have a will or an estate plan created in a previous marriage—which they fail to update. Others assume that if they just leave everything to their new spouse, that person will automatically pass stuff down to the children from each marriage in a fair and equitable manner if they themselves die. Plenty of others never bother to create an estate plan of any kind, or even write a will.

In each case, the result will almost certainly be disaster.

Estate planning in blended families is always a potential minefield that requires a highly specialized skill set from a qualified attorney. The issues blending brings up—both emotional and legal—are extremely complex, but a savvy attorney can help you see around corners and make your assets work for multiple families in ways you didn’t even know were possible.

What Happens if You Don’t Plan: Probate for Blended Families

Let’s start with the worst-case scenario: No plan at all. Whenever someone dies with no clear plan for their estate, or their plan has gone out of date, their estate will likely end up in probate court.

Probate means that a court takes over to decide how a deceased person’s assets should be distributed. It’s often a long, incredibly costly process that far too often results in battles between relatives—especially within a blended family.

Probate is like legal purgatory. With a blended family, it can be worse—perhaps purgatory with a knife fight.

The threshold for probate in California is exceptionally low. You could literally own a square-foot plot of land and your family could end up in probate court if you haven’t built an up-to-date estate plan that not only specifies who gets what when you pass away, and but creates a mechanism through a Trust to pass it properly. Your family could end up paying to argue over that square-foot of dirt for years and years to come.

To give you an example of the costs, probate on a $2 million estate can easily consume between $75,000 and $100,000. That’s money which could have gone to your loved ones, but instead, it’ll go to lawyers and the government. Probate court fees are set by statute, so there’s no shopping around and no negotiating those down.

Just as importantly, probate will likely keep your heirs from inheriting for years. The process of probate in California typically takes up to 16 months, but we’ve seen plenty of probate cases that go on for five years. When major issues—COVID-19, for example—back up the court system, it could take even longer.

Estate Planning in Blended Families: A Simple Case Study

Let’s consider the case of Mark and Kim, two divorcees who marry and have one child together, who is still a minor. Mark, who is considerably older than Kim, has two grown children from a previous marriage as well as grandchildren, one of whom has special needs.

Mark and Kim have a joint home together, rental property, life insurance, and retirement plans. But Mark also has a piece of land and an investment account that he inherited and are held in his name alone.

Naturally, Mark wants to make sure everyone in his life is taken care of upon his death, but as of now, he has plenty of assets and goals, but no plan.

We need to help Mark plan in a way that ensures everyone in his life is taken care of exactly according to his wishes.

Inheriting Assets in Blended Families: It’s Complicated

There are essentially three kinds of property to be considered when planning the estate of a blended family and which we’ll consider for Mark and Kim when planning their trust. An attorney calls this the “Characterization of Assets.”

  • Community property: Any property real or personal, or debt acquired during the marriage.
  • Separate property: Property acquired prior to marriage, after the date of separation, or during marriage by inheritance or gift.
  • Commingled assets: It’s complicated.The Trouble with Commingling Funds in Blended Families

The commingling of assets is where things can get dicey. Really dicey.

Let’s say Mark and Kim sell both Mark’s individually-owned piece of land and their jointly-owned house, and then use those commingled funds to buy a bigger house together. What if Mark never updated his trust from his previous marriage, which left all his inherited property to them? If Mark now dies, are his kids entitled to part of the new house since they were previously set to inherit his personal land? Does it mean Kim isn’t entitled to her part of the house when Mark dies? What if Mark also commingled his individually-owned investment account with Kim?

Add emotion on top of this—fighting siblings, in-laws, estranged children—and the potential for disaster in a probate process to decide all this becomes enormous.

They certainly never aired that episode of “The Brady Bunch,” did they?

Does an Old Will, Old Trust, or Previous Estate Plan Apply in a Blended Family?

What if Mark already has a will from his previous marriage? Won’t that decide who gets what?

Probably not. A will is essentially just instructions to the probate judge about how you would like things to happen. It does not ensure your wishes will be met, especially if it’s an out-of-date will from a previous marriage. Also, if nothing was updated, nothing is clear.

So, how do we make sure Mark’s family does not end up in probate, his assets are distributed according to his wishes, and his goals for both his families are met?

The Good News: There Are Options for Estate Plans for Blended Families

For starters, as soon as Mark married Kim, an alarm should have gone off in his head that he needed to update his estate plan. Any big life event—births, deaths, divorces, marriages, or an inheritance for you, your spouse, or your heirs—are indicators that you need to revisit your estate plan. When Mark and Kim’s child was born, the plan should have been updated again. 

Now, at this point, you might be asking why Mark can’t just leave everything to Kim and let Kim decide how to leave everything to everyone’s kids when she dies?

That’s great in theory, but what if Kim decides not to do that, or does it in a way that Mark’s adult children or ex-wife finds objectionable? Also, keep in mind that in cases like Mark and Kim’s, Kim is the same age as Mark’s adult children, which means that if this is the plan, Mark’s previous children will likely never inherit at all.

A good estate attorney will structure Mark’s trust to make sure specific assets go to the people of his choice in a clean way. For example:

  • Life insurance – Mark could leave his assets to Kim in his trust, but have his life insurance go to his older kids at the time of his death.
  • Specific assets – Remember that land Mark inherited? We might structure things in a way that allows Kim to derive income from this land during her lifetime, but then the land goes to Mark’s first set of children on Kim’s death.
  • A gift off the top – Adding a “Pay on Death” designation to certain bank accounts, held outside his Living Trust, is a simple way to ensure Mark’s older kids get a little cash immediately following his death, outside of jointly-owned assets with Kim.
  • Retirement funds — We’ll delve into retirement funds later, but by federal law, spouses automatically inherit 401(k)s. We can structure things in a way that allows Kim to take the 401(k), and the kids to immediately get some other asset, like the house.

These are just a few examples of how we can structure an estate plan and a Living Trust–all carefully worked out during a consultation.

Retirement Planning in Blended Families 

Retirement planning in any family is complicated, but in blended families, it’s a whole different ball of wax. As we touched on above, retirement funds are often automatically rolled over to a person’s spouse upon death, which means that spouse has complete control over those funds.

In a family that already doesn’t get along, that’s like adding gas to a fire.

Add to that mix the constantly-changing and complicated laws which, at least for the moment, do not necessarily work in the inheritor’s favor—and it’s easy to waste a lot of money.

That said, there is a way to structure your trust so that your money—and your heirs—are protected. An expert in the field can even make your money grow.

By transparently creating an equitable structure, an expert can prevent the fire in the first place.

IRAs and the Secure Act with Blended Families

For most of our clients, an IRA is the biggest asset they’ll ever have—bigger, often, even than real estate. Because of the way IRAs work, when a person passes, it’s usually all still there, which is why it’s so crucial to talk about who inherits these funds when you die, especially in blended families.

Up until 2019, inheritors of IRAs could draw these funds out over a lifetime. This made it a great planning tool, since it stretched that money for years, allowing the interest to grow. It also acted as a bit of a stopgap so that young or less-responsible inheritors didn’t spend it all in a matter of months.

If you think back to what you were like when you were 18, you’ll understand why this is so important.

All that changed, however, with the passing of the Secure Act on January 1, 2020. Now beneficiaries must draw the entire balance from the account within ten years of the account owner’s death. If they choose to, they can even draw it all out in one year.

That means someone like Mark’s youngest child could conceivably withdraw and spend the entire IRA before he’s a teenager. It also means he’ll have an enormous tax bill (the tax on a $1 million IRA is $500,000), and will most likely be bumped up into a higher tax bracket.

The Importance of an IRA Trust for Blended Families

That’s why we’re going to establish an IRA Legacy Trust for Mark.

This is an entirely separate trust than the one he has with Kim. Established in Nevada with a Nevada trustee to avoid California taxes, this trust will allow these funds to stretch as they could before the Secure Act was enacted.

By doing this, Mark has ensured that his minor son cannot draw his entire IRA inheritance as a child. In fact, because of the way we’ll structure the trust, he’ll have to wait until the age of 26 to get it. We’ve now also made sure that Mark’s special needs grandchild will not suddenly come into so much money that she is kicked off Medi-Cal or SSI.

This also allows the account to earn more interest, so even though they’ll have to pay taxes upon withdrawal, his children will ultimately collect much more money than if they had taken out all the funds in the first year.

Mark is also going to leave a percentage of his IRA to Kim and stipulate that when she passes away, the funds go to his adult children. This is something Kim can never change.

By establishing this retirement trust, Mark has much more control over how his retirement funds are handled after his death and has positioned everyone in his family to make the most out of his money. 

Choosing your Trustee as a Blended Family

 Most of us think of trustees as people who handle our affairs after we’ve died, but in fact, trustees step in as soon as you are incapacitated. Sometimes, depending on your Powers of Attorney, that person is not only making decisions about your money, but about your health and care.

Usually, this person is a spouse, but in blended families, you may choose different people for different purposes, and again, that’s where things get complicated.

Does Kim want Mark’s kids making decisions about his health if he becomes incapacitated? What about her health? What about decisions about his estate? As with so many issues in a blended family, the potential for conflict here is enormous.

Sometimes the best successor trustee to handle the financial affairs of someone a blended family will be a professional fiduciary. These are licensed professionals who can be hired to make financial decisions should you become incapacitated or pass away. They go through background checks and you can even interview them so you’re comfortable with who’s handling your care.

This is a great way for a blended family to avoid conflict and your estate attorney can help you arrange this.

Long-Term Care Insurance for a Blended Family

Let’s say that Mark has a stroke. Mark’s medical bills are $10,000 per month. Does that $10,000 come out of the community property or his separate property? Chances are Kim will argue that it comes out of the separate funds. Of course, his kids will argue that it should come out of the community property.

One great solution is long-term care insurance. In a good policy, if whatever you invest isn’t used it goes right back to you with interest. In a blended family, even a wealthy one, these funds can prevent numerous conflicts if you become disabled.

You may be interested in viewing our webinar on Long-Term Care. 

The Role of Your Estate Attorney

Although estate planning for blended families may seem daunting, with a little help and a lot of expertise, the right attorney can help you meet all your goals and leave the legacy that’s right for you.

What Do We Do?

The lawyers and staff at CunninghamLegal help people plan for some of the most difficult times in their lives; then we guide them when those times come.

Make an appointment to meet with CunninghamLegal for California Estate Planning and Trust Administration. We have offices throughout California, and we offer in-person, phone, and Zoom appointments. Just call (866) 988-3956 or book an appointment online. Please also consider joining one of our free online Estate Planning Webinars.

We look forward to working with you!

Best, Jim & Tasha

Attorney James L. Cunningham, Jr., Esq., is the founder and CEO of CunninghamLegal. He is certified by the State Bar of California’s Board of Specialization as a Specialist in Estate Planning, Trust, and Probate Law

Attorney Tasha Jahn holds an LL.M (Master of Laws) in Estate Planning from The John Marshall Law School in Chicago. Prior to this advanced degree, Tasha received her law degree from Western State University College of Law. She practices Estate Law with CunninghamLegal.

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It’s especially important to help your blended family avoid the protracted, emotional purgatory of probate court by creating a properly structured Living Trust while you are alive. Take that vital step as soon as possible.

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