While no one marries with the expectation of divorce, the reality is that divorce is dishearteningly common. The New York Times has estimated that approximately one-third of marriages will end in divorce. As a result, it is prudent to review estate planning for blended families. Your estate plan should ensure that your assets are protected during a divorce, and that your planning documents clearly provide for the beneficiaries of your choosing in blended family situations.
How Can I Protect Assets in the Event of Divorce?
- Premarital Agreement
A premarital agreement is instrumental in defining what is marital property and how assets are to be divided in a divorce. This agreement is especially important in California, which is a community property state, meaning that all assets acquired during marriage are presumptively owned equally by both spouses. A premarital agreement can alter this presumption by defining specific assets, or specific classes of assets, which remain the separate property of either spouse. A common mistake spouses make is that while they realize assets acquired prior to marriage may be their own separate property, if the value of that separate property is increased as a result of the investment by the community (including the time and efforts of a spouse), then the community could acquire an interest in that separate property. Accordingly, should the spouses later divorce, without a properly drafted premarital agreement, assets believed by one spouse to be his/her separate property may actually be credited in large part to the other spouse.
- Buy-Sell Agreement
If one or both of the spouses own an interest in a closely held business such as an LLC or corporation, then a buy-sell agreement should be considered. In this agreement, the owners of the closely held business can mandate that in the event of divorce (or other triggering events such as death or bankruptcy), the shares owned by that individual would be transferred to the remaining co-owners, including him/herself, and the spouse or other beneficiary of the divorcing owner would be paid for that interest. This ensures that the business remains in the hands of those most closely familiar with its operation, and increases the chance of continued business success. At the same time, the ex-spouse is compensated for the interest he/she is releasing, and will have no further affiliation with the business. In other words, if you are a part owner of a corporation, and your co-owner is divorcing his/her spouse, do you ultimately want to run the business with the ex-spouse, or with the partner of your choosing? The buy-sell agreement can result in the owners of the business deciding who will continue to run it, rather than the divorce court.
- Will, Health Care Directive, Power of Attorney, Trust
Often, a married couple will name each other as agent under power of attorney or to make health care decisions. Likewise, spouses will often name the other as executor of a will and/or trustee of a trust. In the event of an impending divorce, or after a divorce is finalized, each spouse should review estate planning for blended families to ensure that it is still relevant. For example, you may not want your ex-spouse to retain rights under power of attorney to manage your affairs. These documents should be updated to ensure appropriate agents and beneficiaries are named.
- Rights to a Life Insurance Policy or Retirement Plan
Assets to consider include pension plans, 401(k)s, IRAs, stock options, annuities and life insurance. Many of these assets will be governed by federal law rather than state law, and will require specialized planning to ensure that they are not only fairly apportioned, but done so in within relevant law. In the event of divorce, you should consult early on with your estate planning attorney as well as with your family law attorney. This helps to ensure that you maximize your rights and benefits to these assets while also understanding estate planning for blended families.
How Does Estate Planning for Blended Families Affect My Plan?
Marrying again, or having children from a first relationship present numerous planning issues.
- Update Beneficiaries
Beneficiary designation forms establish who will be the beneficiary of assets such as retirement plans, insurance and annuities. While a divorced spouse may remember to update wills and trusts to remove an ex-spouse as beneficiary or trustee, individuals will often forget to update retirement assets, insurance and annuities, which do not pass by will. Instead, they will be distributed to the beneficiaries named within those policies, whether or not it matches a person’s will. At an individual’s passing, his/her family may be shocked to learn that the individuals they thought would inherit don’t because the deceased family member forgot to update the beneficiary designation forms. It is a good habit to review your estate planning every few years to ensure that your documents are up to date, assets are not accidentally omitted, and that your beneficiaries and trustees are properly identified and still relevant.
- Coordinate your Estate Planning
Estate planning for blended families is vital. An individual entering into a second marriage or relationship may wish to create estate planning documents to benefit the new spouse, while maintaining existing estate planning documents to benefit children from the previous marriage. For example, a trust might already be set up naming the children as beneficiaries, and upon a second marriage another trust is created for the benefit of the new spouse. Particular care must be taken to ensure that both plans effectively benefit the individuals named. A common mistake includes confusing which assets belong in which trust. If a trust is not properly funded, then the beneficiaries of that trust will not receive the benefit the trustor may have intended, or, worse, litigation among beneficiaries of the competing trusts could significantly diminish the value ultimately transferred to beneficiaries. Another mistake is saddling one trust or beneficiary with all, or a disproportionate share of estate tax liabilities, unjustly enriching some beneficiaries at the expense of others.