After the dust settles on your divorce, it's time to update your estate plan. You may have different long-term plans as a single person than you did when you were married. Plus, the composition of your assets may have changed from when you originally devised your estate plan during your marriage. Here's some information to help revise your estate plan based on your post-divorce circumstances.
Generally, a divorce judgment automatically extinguishes your spouse's rights under your will or any trusts. So there's little danger that your ex-spouse will inherit your property, even if you haven't yet amended your estate planning documents. If you have minor children, however, your plan may inadvertently give your ex-spouse control over your wealth.
Property inherited by minors generally must be held in conservatorships until they reach the age of majority (usually 18). And in most cases, a court will appoint the surviving parent (your ex-spouse) as conservator. Even though the conservatorship will be under court supervision, your ex-spouse may have significant discretion in determining how your assets are invested and spent while the children are minors.
The best way to avoid this result is to create one or more trusts for the benefit of your children. A trust allows you to choose a trustee who'll be responsible for managing assets and making distributions to your children.
Estate planning is also important if you decide to remarry. Suppose, for example, that you have children from a previous marriage. If you haven't updated your will or trusts, a substantial portion of your estate may go to them (under your ex-spouse's control, if they're minors).
It's also important to consider estate taxes, although they aren't as big a concern as they once were. Today, the unified federal estate and gift tax exemption is significantly higher than it has historically been, so relatively few families are subject to the tax. But if your estate is very large, there may be opportunities to reduce or defer estate taxes.
For example, suppose Henry dies with a $50 million estate. He leaves $20 million to his second wife, Marie, which is shielded from tax by the marital deduction. But he leaves the rest to his two children from his first marriage. Any portion that's not shielded by the lifetime exemption will trigger estate tax liability, which is subject to federal estate taxes. Their inheritance also may be subject to state death or inheritance tax, too, if applicable.
If Henry had left his entire estate to Marie, estate taxes would have been deferred until her death. The problem with this approach is that, by leaving everything to Marie, Henry puts his children's inheritance at risk. What if Marie spends it all? What if she remarries and leaves everything to her new husband and children?
Here are two main strategies for people in Henry's situation to consider that will allow them to provide for their kids from a previous marriage while still taking advantage of the marital deduction:
1. QTIP trust. Generally, to receive the benefits of a marital deduction, you must leave property to your spouse outright. The qualified terminable interest property (QTIP) trust is an exception to this rule. A QTIP trust is an irrevocable trust that pays out all its current income to the surviving spouse at least annually and meets certain other requirements. In the example, had Henry transferred assets to a QTIP trust, he could have taken advantage of the marital deduction while preserving the trust principal for his children.
Historically, there was a disadvantage to leaving your entire estate to your spouse, either outright or in a QTIP trust: The marital deduction defers, but doesn't eliminate, estate taxes, so the assets were eventually subject to estate tax as part of the surviving spouse's estate, wasting the first spouse's estate tax exemption.
2. ILIT. Another option is to establish an irrevocable life insurance trust (ILIT) for the benefit of children. By setting up an ILIT, Henry could leave his entire estate to Marie, taking full advantage of the marital deduction, while also providing a generous inheritance for his children. Alternatively, he could leave everything over the estate tax exemption amount, still avoiding estate tax. Either way, as long as the ILIT is designed properly, the insurance proceeds will pass to Henry's children outside of his estate and be free of estate taxes.
Going through a divorce proceeding can be emotionally draining. But try to look at it as a fresh start. Your professional advisors can help you think through the details of your new estate plan and avoid potential pitfalls.
Get in touch today and find out how we can help you meet your objectives.
