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Planning ideas for blended families using life insurance: the marketplace is huge and "gap planning" opportunities for blended families in 2010 are exciting.


At first glance, estate planning for blended families might appear to be a niche market of little consequence for insurance advisors.

The truth is that blended families constitute a significant part of the American population, and may be both misunderstood and underserved by advisors and estate planners. When insurance professionals look back at 2010, many are going to remember the year for its historic and exciting planning opportunities for clients, especially blended families.

Today's American family may not resemble your grandfather's!

Most American households no longer fit the mold of the "traditional family" with a father, mother and children of that marriage. An ever-increasing number of households are better described as "blended families" where one or both spouses have been divorced or widowed, and then remarried.

According to the 2007 U.S. Census, 1,300 new blended families are formed daily. Additionally, about 65% of remarriages involve children from one or both of the previous relationships, and may include children of the current relationship. Today's family includes single parent households (divorced, widowed, or unmarried); persons in heterosexual cohabitation (with or without children); and same-sex unions (with or without children).

Taken together, blended families and other non-traditional households outnumber traditional families. What many advisors may not realize is that blended families have very unique planning concerns and challenges.

Customizing the estate plan for blended families

Blended and non-traditional families share similar objectives, such as:

* Accumulating assets for a secure retirement

* Providing a fair and secure financial legacy for loved ones

* Transferring wealth in the most tax-efficient manner

* Avoiding disruption of family relationships

The bulk of a traditional couple's assets pass to the surviving spouse on the first death, and the children must wait until the second death before receiving their inheritance. This approach tends to focus on achieving zero estate taxes on the first death, financial security for the surviving spouse, and reduction or elimination of death taxes on the second death.

Formulas are often used in wills and trusts to achieve these results. By formula, the estate may be divided into two (or more) shares. The Marital Share to the surviving spouse--outright or in a qualified marital trust (QTIP or QDOT)--takes advantage of the unlimited marital deduction. An amount up to the deceased spouse's federal estate tax exemption is allocated to a Credit Shelter Trust (CST). The exemption is $1 million after 2010, but that may change if Congress intervenes later this year or next.

CSTs can provide three benefits: (1) elimination of federal death taxes on the first death; (2) elimination of death taxes on CST assets (including any appreciation) upon the second death; and (3) implementing specific instructions on the distribution of trust principal and income to the surviving spouse, children, and grandchildren.

In addition, Irrevocable Life Insurance Trusts (ILITs) can provide liquidity upon the first and/or second death through ownership of single life or survivorship life insurance--further strengthening the legacy for the insured's loved ones. Finally, traditional clients may also take advantage of lifetime gifting and intra-family sales strategies.

Conventional techniques often don't work for blended families

For a variety of reasons--some not so obvious--planning techniques for traditional families may not work for blended families. This is precisely where an insurance advisor can bring a professional perspective to the planning process.

Advisors should review how the wills and trusts divide the estate, especially with respect to the use of Credit Shelter Trusts. If the Marital Share is overfunded, the CST's tax sheltering power may be underutilized. Clearly, fact-gathering is critical to get the planning process moving in the right direction. Inquire about current and previous marriages, children and any pre-nuptial agreements.

A major concern for blended families is a possible prolonged delay in the children receiving their inheritance, especially if the second spouse is closer in age to the children than the natural parent. This could result in the legacy not being distributed to the children until their retirement years.

Funding the QTIP Trust: How much is too much?

Almost routinely, advisors encourage the use of a QTIP Trust as the preferred technique for blended families with higher net worth. The idea is to fund the QTIP Trust with some predetermined amount that provides a lifetime income for the surviving spouse. The children would receive trust residue upon their stepparent's death. However, use of the QTIP Trust introduces the complicating factor of delaying or reducing the ultimate legacy for the children.

Using ILITs to help divide the estate fairly

The consultation process, frankly, is "part art and part science" when molding an overall strategy. While over-reliance on a QTIP Trust to support the surviving spouse may squeeze the children's inheritance, an effective solution is to incorporate an ILIT into the blended family estate plan.

In addition to the usual benefits of an ILIT, death benefits received by the ILIT (on a policy insuring the life of the natural parent of the children) can serve as a proxy for the children's inheritance. The insurance money can promote a sense of "family fairness" without upending the surviving spouse's expectations or conflicting with any obligations the natural parent may feel toward the surviving spouse.

For deaths in 2010, consider "overfunding" the Credit Shelter Trust

The year 2010 is an historic year in estate planning! It is the one time since World War II that wealthier Americans can die without federal estate taxes, unless Congress intervenes later this year with retroactive changes.

For deaths during 2010, it may be the only time in the foreseeable future when the decedent's assets allocated to the Credit Shelter Trust can exceed the exemption amount that would otherwise have applied prior to 2010 and after this year. In other words, the wealthier spouse in a blended household who dies this year can pass assets free from federal estate tax, even if the CST is funded with more than $1 million (or even more than last year's $3.5 million amount). In fact, the entire amount of the deceased spouse's wealth can be allocated to the CST without death taxes, provided the death occurs this year, and provided Congress does not retroactively enact an estate tax applicable to the date of the client's death.

This is an example of "gap planning," or taking advantage of a tax opportunity that exists between the zero federal estate rules of 2010 and 2011, with the return to federal death taxes on January 1, 2011. As the tax rules are currently written, clients who die after 2010 will face top estate tax rates of 55% (plus a 5% surcharge on larger estates); an exemption of $1 million; a flat 55% GST tax rate, and a GST exemption of $1.12 million. Overfunding the CST is one example of gap planning for a 2010 death. Other estate planning strategies might include retitling the couple's assets, revising the apportionment formulas, and adopting disclaimer provisions.

If the client adopts "gap planning" for a possible death in 2010, care should be given to react to two possibilities: (1) that Congress may retroactively enact estate taxes for a 2010 death; and (2) a client might live beyond 2010 when federal death taxes return.

Example: John and Sally are married--a second marriage for both. John has two children from his previous marriage. His net worth is $6 million, and Sally's $1 million. If John dies this year (2010), all his wealth could be transferred to his CST without owing federal death taxes. To prevent disinheriting Sally, the CST would include provisions for a specified amount of income for her lifetime. The CST could also specify the time and amount of distributions to John's children. At Sally's death, the trust residue (including any appreciation) will be excluded from federal estate tax. If, however, John dies in any year after 2010, the amount funding the CST would be limited to the exemption amount then in effect.

What to tell clients in blended families?

Encourage all clients to get fresh advice about their opportunities for "gap planning" this year. Carefully review how the Marital and Credit Shelter Shares are to be divided, and how a QTIP Trust can strengthen the legacy to the children of the previous marriage.

Even if a client dies without federal estate taxes, remain alert about state death taxes--the new concern in estate planning. At last count (April 2010), 17 states and Washington, D.C. imposed estate or inheritance taxes. [See, Richard E. Kait, "State death taxes: The new planning concern," Life Insurance Selling (February 2010)].

Although we don't know what the future holds, we do know that life insurance owned outside the taxable estate can hedge against uncertainty and provide liquidity at death. Insurance advisors now have a wonderful opportunity to reach out to blended families and help them plan through the current fast-changing tax environment.

By The Numbers

1,300 new blended families are formed daily. About 65% of remarriages involve children from one or both of the previous relationships.

Source: 2007 U.S. Census

Richard E. Kait, JD, LLM, CLU, ChFC, is Second Vice President, Advanced Sales, and Director of Premium Financing for Protective Life and West Coast Life Insurance Companies.
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Author:Kait, Richard E.
Publication:Life Insurance Selling
Date:Apr 1, 2010
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