Estate planning for blended families

Blended families are increasingly common and as an advisor you’ll likely have clients with children from one or more prior relationships. In most blended family situations, each partner wants to ensure that when they die, their children, as well as their new love, will be treated fairly and will receive as much financial support as possible.

Estate planning to achieve these goals can be complex. In most situations, the typical “all to spouse, then equally to the children” estate distribution will not work. In addition, the competing interests of potential beneficiaries can lead to discord.

This is when many investors will look to their financial advisor for help.

So, the next time a client excitedly announces to you that he or she has found a new life partner who is the love of their life, you should do more than just offer your congratulations. Encourage your client to consider some implications of the new relationship, including the need for an updated estate plan.

Let’s look at a possible scenario, a client we’ll call “Jessica”, who has two adult children from a prior relationship. During a discussion with her, Jessica tells you that she just married “Rob”, who also has two adult children from a prior relationship. She tells you that Rob has sold his home and is buying one-half of her home.

When you ask about her estate plan, Jessica tells you that she wants to ensure that her children receive her assets upon her death but that if she predeceases Rob, she also wants to ensure that he receives some financial support from her assets should there be a need.

What estate planning ideas can you offer to Jessica?

Home

As many couples do, Jessica may be intending to hold title to her home in joint tenancy with Rob (unless she lives in Quebec, where this option is not available). If Jessica then predeceases Rob, he will receive full ownership of the home, allowing him to dispose of Jessica’s former interest in the home in any manner he wishes, including giving it to his own children.

Jessica may believe that, if she predeceases Rob, he will ensure that her interest in the home will eventually pass to her children. However, Rob may not be that trustworthy, either failing to take the estate planning steps necessary to protect Jessica’s children or deciding to give Jessica’s interest to his children.

If Jessica wants to ensure that her interest in the home will eventually pass to her children, she should hold title to the home as a tenant-in-common with Rob. Upon her death, her interest in the home will pass into her estate and her will can stipulate that, if she predeceases Rob, that interest be held in a testamentary trust for Rob’s benefit until he no longer wants to live in the home or until his death.

Jessica could direct in her will that Rob be responsible for payment of all operating expenses respecting the home (such as heat, light, and telephone). And she could also direct that some estate cash be held in the testamentary trust, and invested, to pay for her share (based upon her interest in the home) of any major maintenance or repair expenses respecting the home (such as a new furnace, new paint, or a new roof) and all ongoing expenses (such as mortgage payments, taxes and insurance).

The trust terms could give Rob the right to use some or all of Jessica’s interest in the home (with equal contribution by Rob) to buy a replacement home in case he wants to relocate (perhaps to downsize or to move closer to his family). Any portion of Jessica’s interest which is not needed to buy the replacement home could be retained in the trust (perhaps giving Rob the right to any income produced by that money) or distributed to Jessica’s children.

The trust terms would direct that, upon Rob’s death (or when he no longer wishes to use the home or a replacement home), the nets sales proceeds from Jessica’s interest in the home be distributed to Jessica’s children.

When deciding who will act as trustee for the trust, Jessica will need to consider whether one or more of Rob, her children, or an independent third party should be appointed. Jessica’s children may not be comfortable with Rob as sole trustee, because they may feel that they should also have the right to participate in decisions respecting the home (such as whether a new roof is needed, or what the house should be valued at for fire insurance purposes).

Rob may not be happy if Jessica’s children, and not he, are trustees, because as owner of a one-half interest in the home he may want to ensure that he can participate in decisions respecting the trust’s one-half interest in the home.

Jessica’s friends or other family may not want to act as trustee because they would be caught in the middle of any arguments between Rob and Jessica’s children. However, a trust company would not be concerned about having to settle disputes and may agree to act as an independent trustee. The eventual appointment decision will likely depend to a large degree on the relationship between Rob and Jessica’s children.

RRSP

Jessica will need to decide whether to designate Rob, her children, or her estate as beneficiary for her RRSP (unless she lives in Quebec, where only the estate can be designated as beneficiary). If Jessica decides that her other assets are valuable enough to provide financial support for her children, she may decide to designate Rob as beneficiary because of the resulting tax benefit. He would be entitled to have Jessica’s RRSP assets rolled into his RRSP on a tax-deferred basis. In addition, ownership of the RRSP assets would give him some financial support if needed. Jessica could also designate her children as contingent RRSP beneficiaries so that the assets would bypass her estate (and avoid probate fees) if Rob predeceases her.

Non-registered investments

If Jessica is concerned that, if she predeceases Rob, he will need more financial support than he will receive from her RRSPs and from use of her interest in the home, she can stipulate in her will that her non-registered investments (subject to any amount which she may need to use to fund the testamentary trust holding her interest in the home) will be held in a qualifying spousal testamentary trust for Rob’s benefit for life. She can direct that Rob will receive all income from the trust investments and, if she wishes, even direct that he can receive capital from the trust (but perhaps only for medical or other emergencies). Jessica can also direct that, upon Rob’s death, the remaining trust assets will be distributed to her children (or held in a testamentary trust for their benefit).

Who will act as trustee for the trust? As with the testamentary trust to hold her interest in the home, Jessica will need to consider whether one or more of Rob, her children, or an independent third party should be appointed.

Jessica’s children may not be comfortable with Rob as sole trustee, particularly if the terms of the trust authorize his access to capital. Rob may not be happy if Jessica’s children, and not he, are trustees, perhaps because he may want to ensure that he can participate in decisions respecting investment of the trust assets. Jessica’s friends or other family may not want to act because of potential disputes between Rob and Jessica’s children, but a trust company may agree to act if the value of the non-registered investments is large enough. The relationship between Rob and Jessica’s children will likely have a large impact on the eventual appointment decision.

If Jessica decides that her children, as well as Rob, will need financial support from her non-registered investments, she can stipulate in her will that some of those investments will be held in a qualifying spousal testamentary trust for Rob (with distribution to her children or to a trust for their benefit upon Rob’s death) and that the balance of her non-registered investments will be distributed to her children (or held in a testamentary trust for their benefit).

If Jessica decides that her children have a greater need for financial support than Rob (or that the value of her non-registered assets is not enough to support both Rob and her children), she can stipulate in her will that all of her non-registered investments will be distributed to her children upon her death (or held in a testamentary trust for her children), even if Rob is alive.

Life insurance

If Jessica has life insurance, the death benefit can be treated in much the same way as her non-registered investments. She will have to decide how much, if any, will be held in a qualifying spousal testamentary trust for Rob’s benefit. Any assets remaining in the trust upon Rob’s death can be distributed to her children (or held in a testamentary trust for their benefit). Jessica will also have to decide how much, if any, will be distributed to her children (or held in a testamentary trust for their benefit) upon her death.

Unless she lives in Quebec, any testamentary trust which Jessica decides to establish using the death benefit, whether for Rob or for her children, can be created through an insurance declaration (allowing the death benefit to bypass her estate for probate purposes). Jessica’s decision as to trustee appointment for the trust will be governed by the same considerations as those for trusts created to hold her non-registered investments.

An estate plan which treats both Rob and Jessica’s children fairly, within the confines of Jessica’s financial resources, will generally avoid a successful challenge by a dependent (or, in the provinces which allow it, by a non-dependent) for variation of Jessica’s will. If Rob receives outright ownership of some financial assets (Jessica’s RRSP) and receives the use of and financial support from other assets (Jessica’s interest in the home, possibly some or all of Jessica’s non-registered investments, and possibly some or all of Jessica’s life insurance death benefit), it is likely that Jessica has satisfied her legal and moral obligations to him.

If Jessica’s children receive immediate ownership of some financial assets (some or all of Jessica’s non-registered investments and life insurance death benefit) or if those financial assets are held in a testamentary trust for their benefit, and if Jessica’s children receive a contingent interest in other assets (her interest in the home, her non-registered investments, and her life insurance death benefit), it is likely that Jessica has satisfied her moral obligations to them.

If her children are minors, Jessica also has a legal obligation for their financial support, and it is likely that a larger portion of her non-registered investments and life insurance death benefit (held in a testamentary trust for their benefit) would be required to satisfy that legal obligation. In addition, if Jessica’s children are minors or young adults, the trust which holds her interest in the home could also include terms giving them the use of that interest for a specified period, perhaps to an age at which it is expected that they can complete any post-secondary education they wish to pursue.

Before documenting her estate plan, Jessica should be encouraged to discuss her decisions with Rob and also with her children. Agreement among all parties is not necessary, but discussion will allow others to express any concerns they have with Jessica’s plan. Jessica will have the opportunity to re-arrange her plan to alleviate those concerns, or to explain to the concerned party why no change will be made. If it appears that someone is determined to challenge Jessica’s plan upon her death, steps can be taken to reduce the impact of the challenge.

The thoughts set out above are very basic, and will require modifications based upon the actual circumstances of your blended family clients. For example:

If the age of your client’s new partner is similar to the ages of your client’s children, the children will likely not want to wait until the death of the new partner to receive all of their inheritance. Other solutions will have to be considered. Obtaining additional life insurance is one way to ensure that children receive an inheritance while still allowing the new partner to receive financial support.

If the value of your client’s registered plan is modest, the new partner may want to receive money outright from other assets rather than only having an interest as a lifetime beneficiary. Conversely, if the registered plan value is significant, your client’s children may not be happy if the new partner receives it all.

Your decision to assist a blended family client by providing ideas to facilitate preparation of a superior estate plan will certainly add challenges as an advisor. However, those challenges will undoubtedly produce both personal and financial rewards.

Floyd Gradley is AVP, Mackenzie Investments Tax and Estate Planning Team, and an estate and trust lawyer.

Floyd Gradley