If you’re married and have children from a previous marriage plus children or stepchildren from your current marriage, your family is considered a blended family. And because you’ll likely wish to pass your wealth on to all of your biological children but also provide for your spouse and perhaps any stepchildren, estate planning can get tricky. Two estate planning strategies to consider involve a qualified terminable interest property (QTIP) trust and an irrevocable life insurance trust (ILIT).

QTIP trust: The upside and downside

One of the most effective estate planning tools for blended families is a QTIP trust. This trust is designed to qualify for the estate tax marital deduction, so that assets you transfer to the trust aren’t taxed after your death.

Unlike an ordinary marital trust, however, a QTIP trust provides your spouse with income for life but can preserve the principal for your children from your previous marriage. Note that, when your spouse dies, the trust assets are included in his or her taxable estate.

Under the right circumstances, a QTIP trust is a great tool for balancing competing estate planning goals and preserving family harmony. But in some cases — particularly when one spouse is considerably older than the other — it can hinder estate planning efforts.

For example, Pete and Kim got married 10 years ago and have two children, ages six and four. Pete is age 50 and has two children from a previous marriage, ages 17 and 24. Kim is age 34 and this is her first marriage. Pete wants to make sure that Kim and their young children are provided for after his death, but he also wants to share his wealth with his older children. In addition, it’s important to him that everyone in the family feels they’ve been treated fairly.

A QTIP trust would allow Pete to spread his wealth among the family, however, it has a big disadvantage: Pete’s older children would have to wait until Kim died to receive their inheritance. And with a relatively small age difference between the older children and their stepmother, that could be a long time. Pete worries that such an arrangement would create tension.

ILIT: The alternative

As an alternative, Pete’s advisor suggests an ILIT. The ILIT purchases insurance on Pete’s life, and Pete makes annual exclusion gifts to the trust to cover the premiums. If the ILIT is designed properly, there won’t be any estate tax on the insurance proceeds.

When Pete dies, the ILIT collects the death benefit and pays it out to his children from his first marriage. The older children receive their inheritance immediately, and Pete’s other assets remain available to provide for Kim and the younger children.

Communication is key

Whether you choose a QTIP trust, an ILIT or another strategy, explain your plans — and the reasons behind them — to your children and spouse. Communication is important to maintaining blended family harmony. Contact us with any questions regarding estate planning and your blended family. We’d be pleased to assist you.

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