Blended Family, Special Needs, and Estate Tax

The current plan does not accomplish Eleanor's goals. The home is held in joint tenancy, so on Eleanor's death it passes automatically to George, not through her will and not into a trust for her children. The will leaves everything outright to George. That qualifies for the unlimited marital deduction, so there may be no estate tax at Eleanor's death, but it wastes Eleanor's Massachusetts estate tax exclusion because Massachusetts does not allow portability. George's estate may then include all the assets and face a larger state estate tax at his death. Eleanor's children have no guaranteed remainder interest in the home; George could change his will, remarry, or sell the home.

The $800,000 life insurance policy is included in Eleanor's estate because she owns it, even though the children are beneficiaries. That adds to the Massachusetts estate tax base. The policy proceeds go to the children and are not available to pay estate tax or expenses, so the estate may have to sell assets or borrow. Claire's outright inheritance would also be a problem: a direct bequest could disqualify her from SSI and Medicaid. The plan needs lifetime trusts, not outright transfers.

Sever the joint tenancy on the home and place Eleanor's interest in a revocable trust. The trust can give George a right to live in the home for life, with the remainder to Eleanor's children. A credit shelter or bypass trust funded with up to the Massachusetts exclusion can benefit George during his life while keeping the assets out of George's estate and preserving Eleanor's exclusion. The rest can go to a marital trust for George, with the remainder to Eleanor's children, so George is provided for without giving him unlimited control.

For Claire, create a third-party special needs trust funded at Eleanor's death, not an outright inheritance. The trustee should have discretion to supplement, not replace, public benefits, and should avoid distributions for food and shelter that would reduce SSI. Do not name Claire individually as beneficiary of the IRA or life insurance. A conduit trust may be considered for IRA proceeds, but an accumulation trust is often better for needs-based benefits; the tradeoff is compressed income tax rates and the 10-year distribution rule. Life insurance can fund the special needs trust without using estate assets. Mark can receive his share outright or in trust. Review all beneficiary designations so the IRA and insurance coordinate with the trust plan.

Eleanor should transfer the $800,000 policy to an irrevocable life insurance trust, or have the trust apply for a new policy. If she transfers an existing policy and dies within three years, the proceeds are generally pulled back into her estate under §2035, so act now while she is insurable and healthy. The trust should be drafted with a trustee who can manage both liquidity and special needs distributions.

The trust can split the death benefit: part to provide estate liquidity or equalize inheritances, and part to fund or supplement Claire's special needs trust. If the estate needs cash for Massachusetts estate tax, the ILIT trustee can lend to the estate or purchase assets from it, but the trust should not be required to pay estate debts. Keep the special needs trust as a separate subtrust with its own trustee and distribution standards. Do not make Claire a direct beneficiary of the ILIT. Coordinate the ILIT with the revocable trust, the IRA beneficiary designations, and George's own estate plan so the same assets are not taxed or distributed twice.