Estate Planning in Second Marriage Situations

Overview

A married couple’s estate planning goals and objectives often dovetail - benefit the surviving spouse for life with the remaining property at the death of the surviving spouse passing to the children.  But, estate planning when a second marriage (either as a result of death or divorce) is involved is more complex, especially when each spouse has children from the prior marriage.  The estate planning techniques of first marriage situations often don’t work when a second marriage is involved.  But, the IRS recently blessed a second marriage estate planning technique.

Estate planning for second marriages – that’s the topic of today’s post.

Second Marriage Estate Plans

Potential problem areas.  Blended families are not uncommon.  When I first started practicing law, I was tasked with developing an estate plan for an older married couple.  Each one of them had outlived their prior spouse and each of them had children from that prior marriage.  They each had a separate farming/ranching operation.  It was imperative to them that their respective children carry on the farming/ranching business that was associated with each of them.  In this situation, the common estate plan for a married couple wouldn’t work.  It was no longer appropriate to balance ownership of all assets equally between the couple and then via reciprocal (i.e., mirror) wills leave a portion of the assets to the surviving spouse outright with the balance in a “credit-shelter” trust and the remainder at the death of the surviving spouse split between all of the kids (from both prior marriages).  This standard approach could have resulted in children of one family eventually owning the other family’s farming/ranching operation.  That would not have been a good result.

It's also common in first marriages for the spouses to own the home and land as joint tenants with right of survivorship. Upon the death of the first spouse, the jointly held asset automatically passes to the surviving spouse.  While that results in the surviving spouse having complete ownership of the asset, that is often not a desirable outcome in a second marriage situation.  The survivor could leave the asset at death to their children of the first marriage. 

Beneficiary designations can also lead to a similar problem as jointly held property.  The spouse is often named as the beneficiary of life insurance, retirement plans/accounts, etc.  But, this can become a problem upon death and the subsequent remarriage of the surviving spouse. 

Potential solution.  One approach that is used in second (and subsequent) situations involves a revocable trust that is funded either during the grantor’s life or at death or via beneficiary designations (or some combination).  The grantor can amend or revoke the trust at any time before death, and on death the trust becomes irrevocable and continues for the surviving spouse’s benefit and the benefit of the children of the first marriage.  The trust income can be paid to the surviving spouse during life and the trust assets remaining at the surviving spouse’s life pass to the grantor’s children of the first marriage.  A “spendthrift” provision can be added to the trust to provide additional assurance that the assets ultimately land in the correct hands, and are not dissipated by creditors, etc.  In addition, the trust allows the grantor to maintain post-death control over the assets of the family from the first marriage.  The assets are not left outright to the surviving spouse of the second marriage, and the surviving spouse cannot change the estate plan to exclusively benefit the survivor’s own children, for example.

Handling Retirement Plans 

In second marriage situations, can an individual retirement account (IRA) also be placed in a trust so that account income benefits the surviving spouse of the second marriage for life with the account balance passing to the children of the pre-deceased spouse’s first marriage?  The tax code complicates matters, but a recent IRS private letter ruling shows how it can be accomplished. 

In general, annual required minimum distributions must be taken from traditional IRAs at the required beginning date (RBD) – April 1 of the year after the year in which the account owner turns 70 ½.  I.R.C. §401(a)(9)(C)(i)(l).  Special rules apply when the IRA owner dies after the RBD.  In that case, any balance remaining in the account is distributed in accordance with certain rules. For example, if the account owner didn’t designate a beneficiary, the post-death payout period is determined by what the deceased owner’s life expectancy was at the time of death.  Treas. Reg. §1.401(a)(9)-(5).  If the IRA owner named a non-spouse as the beneficiary, the account balance is paid out over the longer of the remining life expectancy of the designated beneficiary or the remaining life expectancy of the IRA owner.  Id. 

If the IRA owner designated the spouse as the IRA’s sole designated beneficiary, the required distribution for each year after death is determined by the longer of the remining life expectancy of the surviving spouse or the remaining life expectancy of the deceased spouse based on their age at the time of death.  Id. This can allow payouts to be “stretched.”  But, naming the surviving spouse as the beneficiary of an IRA also gives the surviving spouse the ability to treat the IRA as their own.  That means that the surviving spouse can name their own beneficiaries – not necessarily a good result in second marriage situations where each spouse has children of a prior marriage. 

Trust as a beneficiary.  Can a trust be named the beneficiary of the retirement plan so that the surviving spouse doesn’t have complete control over the account funds?  In general, the answer is “no.”  Treas. Reg. §1.401(a)(9)-4, Q&A 3.  However, a trust beneficiary (with respect to the trust’s interests in the IRA owner’s benefits) is treated as the designated beneficiary of an IRA if certain conditions are satisfied for the period during which the RMDs are being determined by treating the trust beneficiary as the designated beneficiary of the IRA owner.  See Treas. Reg. §1.401(a)(9)-4, Q&A 5(b).

Recent IRS ruling.  In Priv. Ltr. Rul. 201902023 (Oct. 15, 2018), the decedent created a revocable living trust during life.  The trust contained a subtrust to hold the benefits and distributions from his retirement plans (and other assets).  He died after attaining his RBD and after distributions from his IRA had started.  The revocable trust and the subtrust became irrevocable upon his death.  His IRA named the trust as the beneficiary.  The terms of the trust specified that property held by the subtrust were to be “held, administered, and distributed” for the sole benefit of his (younger) surviving spouse.  Upon her death, the trust specified that the retirement plan (along with the remaining assets of the subtrust) were to be divided equally between his children or their descendants.

The IRS noted that the trust identified the surviving spouse as the sole beneficiary of the subtrust in accordance with Treas. Reg. §1.401(a)(9)-4, Q&A 5(b)(3).  In addition, the trust required the trustee to pay the surviving spouse any and all funds in the subtrust that the trustee withdrew, including RMDs, and there could be no accumulation for any other beneficiary.  That satisfied the requirements of Treas. Reg. §1.401(a)(9)-4, Q&A-5 (valid trust under state law; trust is irrevocable or becomes so on death of account owner; the trust identifies the beneficiary; and the plan administrator is given appropriate documentation) and the surviving spouse was treated as the sole designated beneficiary of the IRA.  Thus, the IRS concluded that the payment to the two trusts (first to the revocable trust and then to the subtrust) was permitted by Treas. Reg. §1.401(a)(9)-4. Q&A-5(d) which says that if the trust beneficiary is named as the beneficiary of the account owner’s interest in another trust, that beneficiary will be treated as having been designated as the beneficiary of the first trust and, be deemed to be the IRA account owner for distribution purposes.    

In addition, the IRS determined that because the surviving spouse had a longer life expectancy that did the decedent, the applicable distribution period for the IRA should be based on her life expectancy.   This means that via the trust and the subtrust, the surviving spouse received RMDs as if she were the designated sole beneficiary.  Upon her death, any remaining assets of the subtrust will be distributed to the pre-deceased spouse’s children or their descendants.

Conclusion

Unique estate and business planning issues present themselves in second marriage situations.  Along with a well-drafted marital agreement, other steps should be taken to ensure the continued viability of separate farming/ranching operations that are brought into the subsequent marriage while simultaneously benefiting each spouse’s children of the prior marriages appropriately at the death of their respective parent.  Included in this planning is the treatment of retirement accounts.  The recent IRS ruling illustrates one way to leave an IRA to the spouse of a second marriage and avoid negative consequences.