Many of my clients are couples in their second marriage. Sometimes they have children from a prior marriage. Sometimes, they have separate property as well as property they own with their spouses. I set forth in this newsletter general information that affects the estate plan for people in second marriages. In most cases, you should consult with your estate planning attorney (like me) to see how best to tailor your estate plan to your particular circumstances.
REAL PROPERTY OWNERSHIP
When couples in their second marriage own real property together, they may take title to such property as tenants in common. This is usually done when the one or both of the spouses have children from a prior marriage. As tenants in common, the deceased spouse’s interest can pass to the children under his or her Will. (The property may also pass under the deceased spouse’s living trust if the interest in the property was titled in the name of the trust.) The surviving spouse’s interest remains with the surviving spouse.
The problem with this approach is that the children from a prior marriage are now on title with the surviving step-parent. What if they don’t get along? A quarreling tenant in common can force the sale of property even if the other co-owners don’t want to sell it. This is called a “partition” lawsuit. If successful, the court orders the property to be sold and the proceeds are divided among all the tenants in common.
DISPARATE AGES OF HUSBAND AND WIFE
Sometimes in second marriages, one spouse is much younger than the other. If the elder spouse dies, and has children from a prior marriage, those children are often forced to wait until the death of the step-parent before receiving the benefits of their parent’s estate. This result leads to hurt feelings and even lawsuits by the children who want to receive the benefit from their parent’s estate nearer the date of death.
One solution is to purchase life insurance on the elder spouse with the children of that spouse named as the beneficiaries. This enables the children to receive some benefits upon their parent’s death without reducing the assets available for the care of the surviving spouse. If the children are minors, such interests should be held in trust.
SEPARATE PROPERTY OF A SPOUSE
Couples in their second marriage often have significant assets in their own name from the death or divorce of their former spouse. Title to such assets are held as an unmarried person as his or her separate property. Upon the second marriage, the title may not be changed. If there is no prenuptial or postnuptial agreement controlling such property, the new spouse may have a claim on the property under California community property law.
The issue is further complicated because community property is treated differently depending upon whether the couple divorces, or one spouse dies. For this reason, many couples choose to sign either a prenuptial agreement, which is done before they marry, or a postnuptial agreement which is done after they marry. In both cases, the couples’ separate and community property interests should be addressed and a schedule of which assets belong as the separate property of each spouse and which are community assets should be attached. To be fully effective, the husband and wife should each have an attorney representing their interests.
In addition to setting forth separate property interests, all couples can benefit from a marital property agreement concerning ownership of the couples’ community property. Current California community property law provides that each spouse owns an undivided interest in each and every item of community property owned by the spouses. When one spouse dies, each and every item of community property must be fractionalized in order to properly fund the by-pass and survivor’s trusts.
A marital property agreement which provides that the couple owns their community property under an aggregate theory of ownership, in which each spouse owns an undivided interest in the whole, allows the sub-trusts to be funded by allocating whole assets to one or the other trust rather than fractionalizing each spouse’s interest.
The conflict between the interests of the surviving spouse and the deceased spouse’s children from a prior marriage arises on the deceased spouse’s death. Most living trusts state that the surviving spouse is to receive income from the assets held by the by-pass trust. The terms usually provide that children from the prior marriage receive those assets upon the death of the surviving spouse. The problem is that investing for the highest current income is not a proper investment for capital appreciation. This is one reason why I suggest the use of the total return trust for assets held in the by-pass trust.
Using a total return trust enables the surviving spouse to benefit from the capital appreciation of the underlying asset because interest payments are calculated as a percentage return on the value of the underlying asset. As the assets increases in value (good for the children), the surviving spouse receives an increase in income (good for the spouse).
LOSS OF ESTATE TAX SHELTER
Sometimes couples in second marriages only have separate property and no community property. In that case, the husband and wife each have their own living trust which holds their own separate property. Many of those separate trusts state that the property is to be held in a QTIP (qualified terminable interest property) trust for the benefit of the surviving spouse for his or her lifetime, after the deceased spouse dies.
The advantage of holding separate property in a QTIP trust for the spouse is that it will qualify for the unlimited marital deduction currently available under federal tax law, and no estate tax is due on the deceased spouse’s death. The disadvantage of holding separate property in a QTIP trust for the spouse is that all of the property held in the QTIP trust is included in the surviving spouse’s estate. The benefits of the deceased spouse’s applicable exclusion amount, which is normally held in a by-pass trust, is lost because such a trust is not created nor funded under typical separate property trusts. This means that all of the assets which go into the QTIP trust are taxable upon the death of the surviving spouse because they are included in his or her estate. The children from a prior marriage lose part of their benefits to unnecessary estate tax. If this is the way your trust is set up, call your estate planning attorney immediately.
NEED FOR ESTATE PLANNING ATTORNEY
So, how do you provide for a second spouse for his or her lifetime and also provide for children from a prior marriage? Your estate planning attorney can develop the appropriate plan for you.