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Estate Tax Strategies for Second Marriages

Posted in Divorce & Matrimony, on Feb 2015, By: Mark S. Gottlieb

Second marriages are not only for Hollywood celebrities like Brad Pitt or Reese Witherspoon. According to the Pew Research Center, 40 percent of marriages today are second marriages. Often second marriages face many complications. Whether it is the terms of a prior divorce, finding a way to harmonize their two career paths, or children from a previous marriage, the situation can become very complex.

A necessary thing to consider during a second marriage is estate planning. Usually, in a first marriage, the estate planning is straight forward. However, in a second marriage, especially one with children, this becomes complex. You want to provide for both your new spouse and your children from your first marriage, and you would like to do so with the least amount of tax impact on your estate. The good news is there are ways to reduce the tax effects a second marriage can have on your estate, and by taking some steps, you can secure the most benefits for your family when you pass.

Estate Tax

According to the Internal Revenue Service, the Estate Tax is “a tax on your right to transfer property at your death […] It consists of an accounting of everything you own or have certain interests in at the date of death.” This can include savings, property, investments, and business interests.

It is important to remember that this estimation is not based on what the value of the assets and property were when you acquired them, but rather their current market value. However, not everyone must pay a Federal Estate Tax; your estate must be over $5,430,000 (2015) to be taxable. In fact, anything up to this amount of an estate is exempt from tax.

What’s most important to know in regard to second marriages, is, that as of January 1, 2011, estates of decedents survived by a spouse can pass any unused exemption to the surviving spouse. This means that if one spouse only uses $1,000,000 of their tax exclusion at death, the remaining $4,430,000 can be used by the surviving spouse, totaling $9,860,000 in total exemption.

The QTIP Trust

Don’t let the name fool you, a QTIP trust is the best tool for reducing the tax consequences of a second marriage, as well as ensuring all your survivors are cared for according to your wishes.

QTIP stands for “Qualified Terminable Interest Property.” It allows you to do two main things:

  • To place conditions on your property, rather than leaving it to a spouse outright, and
  • When one spouse dies, it allows the survivor to determine the amount of the deceased’s property should be held in trust to maximize estate tax savings.

The first benefit of a QTIP is best suited to ensuring all of your beneficiaries are taken care of from your estate in the event of your death. The second benefit of a QTIP trust may help reduce taxes. Don’t be mistaken, a QTIP trust does not eliminate taxes, it simply postpones them until the death of the second spouse. However, due to frequent changes to estate tax law and factors such as depreciation or appreciation of investments, this postponement may save your estate from many unwanted taxes.

The Irrevocable Life Insurance Trust

An Irrevocable Life Insurance Trust ILIT is created to contain one or more policies insuring your life. Technically, the trust owns the policies and pays the premiums. The ILIT is irrevocable, which means that you cannot change the terms of it once it has been signed. Also, neither spouse can be chosen as trustee of the ILIT.

Some of these conditions sound rather off-putting, such as the stipulation that you no longer own your own life insurance once it is in an ILIT.

But it is precisely this element that makes the ILIT advantageous. Because neither spouse is the trustee of the trust, technically it is not controlled or owned by them, and, therefore, is separate from the total estate. That means that when a spouse is deceased their life insurance cannot be taxed because it is separate from the estate, and the money secure in the trust is available to the beneficiaries tax-free.

Gifting

Another way to possibly reduce taxes on your estate is by annual gifting. As of 2015, a gift up to $14,000 a year per recipient is tax excludable. These gifts can come in the form of cash or any other assets that make up an estate. However one may run into the problem of giving complete control over these funds to the recipient. Imagine giving your 12 year old $14,000—chaos would ensue.

One way to maintain control over the funds is called a “Crummey” trust. This is a trust in which the recipient of the funds have a small window in which to withdraw, once the window has passed the funds become tied up in the trust until after the donor’s death. The obvious pitfall of this method is if the recipient wants, they can withdrawal the gift during the window. However, if the recipient is trustworthy and is informed of the benefits of waiting until after the giver’s death, this method can work to limit estate taxes.

Another method, a common one, is to establish a trust for a minor. This works best for those with smaller children. In this way, the trust can dispense the gifts tax-free directly to a beneficiary. Yet, the one weakness here is that once the recipient is 21, the entire remaining sum passes directly to the minor. As we all know, not all 21 year olds are responsible with money.

Prenuptial Agreements

The hard truth is that when going into a second marriage, it may be best to set up a prenuptial agreement in addition to the other methods. A prenuptial agreement plainly sets out what each spouse’s assets and liabilities truly are, and how these will be divided (or combined) during the marriage and after it ends.

Benjamin Franklin said, “By failing to prepare, you are preparing to fail.” Many people believe that prenuptial agreements presuppose that a second marriage will fail. This is far from the case. The most important reason to draw up a prenuptial agreement is so that a clear path is set for the division of estates in the event of a spouse’s death.

The last thing someone wants to worry about when they are about to get married is taxes and what will happen to their estate. Establishing tools such as a QTIP trust, ILIT life insurance trust, or strategically gifting can help you to not only secure where and to who you want your estate to go, but also drastically reduce the amount which needs to be given to the government.

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