Legal trust solution for ensuring your estate doesn’t go to someone else’s kids

Topics Covered:

  • Restates the problem of a spouse in a blended family passing away, the surviving spouse remarrying someone with children and the deceased spouse’s child ending up with nothing of the estate
  • Explains shortcomings of a Mutual Will solution to the problem
  • Explains the imperfect solution of a legal trust
  • Outlines problems with the legal trust solution

What tools, besides mutual wills, can ensure my hard-earned assets go to my kids?

That question was a sequel to an earlier column but the last few weeks I was distracted having been involved in a senseless vehicle crash and I wrote two road safety columns.

So, I’ll start by restating the problem and then reminding you how mutual wills are an imperfect fix.

Gail is a 40-year-old divorced mother of a 20-year-old daughter. She finds love with Ron, age 35, who has no children. Gail goes into the relationship with significantly more assets than Ron.

Ron moves into Gail’s house and their assets are combined.

Ten years into the relationship, at ages 50 and 45 respectively, Gail and Ron have wills written. They go with the classic will approach of leaving everything to each other, with the estate going to Gail’s daughter when the last of them dies.

Gail sadly dies of cancer at age 55. Ron, now 50, quickly finds love with a younger partner Patricia, aged 35, who brings three children into their new relationship. Gail’s daughter becomes estranged from Ron, upset at how quickly he shacked up with a new partner who’s the same age as she is.

Ron changes his will to leave everything to his new partner. Gail’s daughter ends up with nothing of an inheritance.

A “mutual will” is an imperfect fix. A mutual will is when the will-makers have an agreement (contract) that neither of them will ever revoke their wills. If they had done that, Ron changing his will would have breached that contract and Gail’s daughter would have legal recourse to right that wrong. But mutual wills do nothing to stop Ron from frittering away the assets to nothing.

And what if Ron has a child or two with his new, younger partner and/or adopts her children? Those children will have a legal claim they can pursue against Ron if he doesn’t leave them anything in his will.

The only protection mutual wills give is handcuffing each other from ever revoking their will. The assets themselves are not protected. An alternative would have been simply for Gail to transfer her assets to her daughter instead of combining them with Ron’s assets. That’s a bed alternative, though, because Gail wants to enjoy her wealth herself. She would also like to ensure Ron is looked after if she dies before he does. She just wants whatever’s left over after she and Ron die to go to her daughter.

There are other fixes, but they are also imperfect. One is to use a legal beast called a “trust.” A trust is not a separate legal entity, but it behaves sort of like it is.

Gail, the “settlor” could have transferred her assets out of her name and into the name of a trust. When doing so, she would have named herself as the “trustee”—the person with control over the trust assets. That would have allowed her to use whatever she wanted of trust assets while she was alive. And she would have named someone she could rely on to take over as trustee after she died.

That new trustee would have been required to follow the rules Gail set up for the trust, which would have included providing Ron with some level of financial support from the trust while he was alive.

The trust rules would also have provided that whatever’s left of trust assets would go to Gail’s daughter on Ron’s death. Regardless of the new relationship or new children Ron has after Gail’s death, the assets within the trust would have been protected.

Because assets are in the name of the trust, and not in Gail’s name, there’s no probate process, expenses and fees on Gail or Ron’s death.

Sound ideal? Unfortunately, there are many downsides.

Trusts are expensive to set up, with lawyers charging in the range of $5,000 to $10,000 and up. And there are significant tax implications. Except for special kinds of trusts that can be set up only after you’re 65, transferring assets into a trust is treated similarly to transferring assets to another person for tax purposes, triggering capital gains.

And trusts are required to file tax returns. The income tax payable on annual income earned on trust assets that’s not paid out to beneficiaries is at the highest personal marginal rate.

The most challenging limitation of trusts is the one that makes all estate planning difficult. It’s impossible to foresee and plan perfectly for the future. What if Ron never finds love again and suffers an injury that prevents him from working? Or he becomes ill with a disease requiring expensive care that exceeds the amount of trust income that has been allotted.

In those circumstances, Gail would have wanted her life partner to have full access to her assets, not limited to an annual level of support that preserves a bunch of money to eventually go to her daughter who won’t need it anyway.

Clever drafting of trust terms can anticipate and plan for many future possibilities. But the possibilities are endless, and no set of terms can perfectly plan for them.

Blended families have become the norm. The classic will that leaves everything to the other spouse and then to the children becomes inadequate when stepchildren are involved.

There’s no perfect fix, but there are some tools that can provide imperfect solutions.

My columns are intended to provide general information and cannot be relied on to make estate planning decisions. Please consult with a lawyer and estate tax accountant to explore all options as they might apply to your specific situation.

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