Estate planning for a blended family

Blended families have long been familiar features of the Canadian landscape. But they can still create an extra challenge with estate planning.

One of the most common difficulties is how to balance the interests of a new partner with the interests of children from a prior relationship.

Relationship dynamics matter

Conflicting interests may not be an issue if all parties have a good, or even cordial relationship. A spousal trust is a workable solution, even with acrimony, but only if there’s enough capital so that even if a spouse draws a generous sum there’s still enough for the children.

Also, suppose a child blames your spouse for the breakdown of her parents’ marriage, or believes your spouse is out for your money. Then every decision of the trustees will almost certainly be closely scrutinized. Resolutions in these cases can take years.

There are options for mitigating such conflicts. You could consider including cash legacies in your will for your children. They would provide an immediate benefit, which may help avoid, or at least diffuse, confrontations concerning the size of a new spouse’s capital encroachments.

Alternatively, you could divide the residue of your estate between all children. Your children would get their shares outright; your spouse’s shares would either be held in a spousal trust or distributed outright. If the entire residue is distributed outright, it eliminates the conflicting interests that a spousal trust creates between parties.

But this solution isn’t perfect. Since the deferral of capital gains tax on death only applies to assets transferred to a spouse or a spousal trust, there will be no deferral for the residue given to your children. Still, you may decide the goal of maintaining peace within the family is more valuable than the tax savings.

Consider provincial law

If you live in Ontario, you need to consider the Family Law Act. It says when one spouse in a married couple dies, the surviving spouse may choose to get an equalization of net family property rather than gifts given in the will (rules of intestate succession apply where there’s no will).

This is the same calculation, with some modifications, that married couples go through when there’s a marriage breakdown. It aims to equalize the respective growth of each spouse’s net worth during the course of the marriage.

In general, the Family Law Act is that whenever a spouse does not receive at least half of the residue, there’s a possibility that the equalization payment will be greater than the gift under the will.

For example, suppose you decide to make specific gifts of your personal property and several cash legacies to named beneficiaries. You then leave one-third of the residue of your estate to two children and a spouse. In that case, your spouse could receive more through an equalization payment than under the will. The outcome will depend on a number of factors, including whether your spouse is named as a beneficiary under a life insurance policy or plan, or whether you owned property as joint tenants.

It’s much more common for a spouse to receive less than the entire residue in the case of a blended family. That increases the potential for a spouse to advance an equalization claim, which can overturn an otherwise well-planned estate. One way to avoid this outcome is to enter into a marriage contract for the limited purpose of mutually waiving the right to make an equalization claim.