I’m going to turn a popular estate planning technique upside down.
The technique I’m referring to is leaving trusts to provide for your surviving spouse, and then upon his or her death leaving the remainder to your children.
These are commonly referred to as “Marital” or “Family” trusts. There is a difference between the two. A Marital Trust generally refers to a trust that qualifies for the federal estate tax marital deduction, which leaves amounts exclusively for the surviving spouse until her death. A Family trust usually does not qualify for the marital deduction, and can be left exclusively for the surviving spouse or may be sprinkled among the surviving spouse and other beneficiaries.
In situations where your spouse is not the parent of your children, these trusts can become problematic, as I’ll describe below. Keep in mind that a trust that continues for the lifetime of a spouse and then distributes to children at his or her death ties all of the parties together economically.
I can best illustrate the issues with an illustration.
“Alan” was a physician who had been in a second marriage with “Sally” for over twenty years. He had two adult daughters from a prior marriage, “Betty,” age 32 and “Carla” age 30. Alan instructed his attorney to create a Marital Trust for the benefit of Sally for her lifetime. The trust was to pay Sally income, with principal invasions authorized for her health, maintenance and support if the income was insufficient for those purposes.
Every dollar that Sally received from the trust was one less dollar that would ultimately be distributed to Betty and Carla. Betty and Carla wanted the trust to invest in more growth-oriented holdings, since they were interested in receiving as much as possible when Sally died. Sally, on the other hand, who relied on the income from the trust to pay her monthly bills, naturally desired that the trustee invest in high income producing assets.
The trustee, whoever is named as such, has a fiduciary duty to balance the needs of Sally against the needs of Betty and Carla. In other words, the trustee shouldn’t invest all of the trust in either growth or income producing assets, but rather a healthy percentage of each, unless the language of the trust itself directs otherwise.
Many such trusts don’t instruct the trustee at all as to which of the beneficiary’s needs takes priority. Consequently, the trustee must assume that Alan, here, would have wanted the needs balanced. Imagine if either Sally, Betty or Carla are also serving as trustee. In this case, they have a conflict of interest that could present some problems, although it is common to have family members serve in this role. So long as the family gets along, then problems normally don’t arise. But when Alan died, the glue that held the familial relationship may have died with him, thus straining the family with the economic relationship.
There are alternatives. One alternative is the Family Trust, that can sprinkle its benefits between Sally, Betty and Carla during Sally’s lifetime rather than the daughters having to wait until the step-mother’s death to enjoy the fruit of the trust. This presents additional problems, particularly if the trust language doesn’t speak to the relative priority of the beneficiaries.
Another, less common alternative is to invest in an insurance policy. Imagine if Alan had instructed his attorney to draft the language of his trust to first address Sally’s needs as opposed to Betty’s and Carla’s. Understanding that Sally might consume the entire trust, or, at a minimum live a long life which would delay the daughters’ inheritance, Alan might look into purchasing an insurance policy. He could name Betty and Carla as the outright beneficiary to the policy, thereby ensuring that they receive at least some inheritance immediately after his passing.
Insurance could therefore be used to mitigate the economic tension that might otherwise exist between the surviving spouse and Alan’s daughters.
That’s just one alternative. In any event, if you have a situation similar to Alan’s, you should carefully review the trust language to ensure that your intent is clearly stated, and direction is provided to your trustee.
© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.