Blended-Family Estate With IRA and Life Insurance
Second marriage: he is 68, she is 65. He has $12 million: $4 million IRA, $3 million brokerage, $2 million residence, and $3 million life insurance owned by him. She has $2 million of her own. He wants her to have income for life from all assets, but at her death he wants the remainder to go to his two children from his first marriage. She wants outright control and says she will “do the right thing.” His children distrust her. The estate is below the current federal exclusion, but his attorney warns about sunset and state tax. The IRA beneficiary is currently his wife outright. The life insurance has no ILIT. They live in a state with a 16% estate tax and a $2 million exclusion.
1. Design an estate plan that gives the wife income for life but preserves the remainder for his children. Address the state estate tax and the federal exclusion.
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Use a credit shelter trust funded with assets up to the state exclusion, about $2 million, to use his state exclusion. Give the wife income from that trust and the remainder to his children. Use a QTIP trust for the balance of his estate to qualify for the federal marital deduction; the wife receives income for life and the remainder passes to his children. Consider a Clayton QTIP or disclaimer to give her flexibility. Weigh the state tax saved against the loss of a second step-up for credit shelter assets. Elect portability for any unused federal exclusion. Use an ILIT-owned life insurance policy to provide liquidity for state estate tax and to equalize the children. Do not give the wife outright control if the goal is to guarantee the remainder to his children.
2. What should be done with the $4 million IRA and the $3 million life insurance policy?
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For the IRA, naming the wife outright gives her control and allows a spousal rollover, but she could change beneficiaries. Naming a QTIP trust can restrict the remainder to his children, but the trust must be a see-through trust and the SECURE Act rules must be analyzed. A trust does not get a spousal rollover; a conduit trust with the wife as sole beneficiary may allow spousal RMD treatment, but the children will face the 10-year rule after her death. Confirm with counsel. For the life insurance, transfer ownership to an ILIT to remove $3 million from his estate, but note the three-year lookback for an existing policy. Fund premiums with annual exclusion gifts or loans, and avoid incidents of ownership.
3. How should they handle beneficiary designations, basis step-up, and the children’s distrust?
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Beneficiary designations control over the will, so coordinate every account with the trusts. Outright to the wife gives a step-up at the second death but no guarantee to the children. QTIP assets are included in her estate and get a step-up, while credit shelter trust assets generally do not get a second step-up unless a limited power is used. Consider giving the wife a limited power of appointment to adapt to changing circumstances. To address the children’s distrust, use an independent trustee, transparent trust terms, and a family meeting. Life insurance can equalize inheritances. Avoid naming the children directly as IRA beneficiaries if the wife needs income. Document the intent and review the plan after any tax-law change.