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Estate Planning for Second Marriage

A suggested alternative approach to a QTIP trust plan can avoid certain obstacles to success for a client.

Natalie Choate, 05/13/2011

Natalie Choate will be speaking at a location near you if you live in Waltham, Ma. (6/3/11); Wilmington, Del. (5/26/11); Indianapolis (6/10/11), South Bend (9/15/11), or Evansville (11/16/12), Ind.; Rochester, N.Y. (6/15/11); Columbus, Ohio (7/21/11); Sioux Falls, S.D. (9/16/11); St. Louis, Mo. (9/26/11); San Diego, Calif. (10/28/11); or Memphis, Tenn. (12/1/11). See all of Natalie's upcoming speaking events at http://www.ataxplan.com/seminars/schedule.cfm.

Question: My client, who has a significant 401(k) plan through his small business, is getting remarried at age 64. Following the marriage, his estate planning goal is to have his new spouse (now age 58) be named as life beneficiary of his plan benefits, entitled to receive only the minimum required distribution, with any balance remaining at the spouse's later death to pass to the client's children (currently ages 40 and 35). He wants the benefits to qualify for the marital deduction for estate tax purposes, but does not want the wife to be able to access a lump sum distribution or change the successor beneficiaries. Further complicating this, when my client dies, the business will come to an end and have to be liquidated, which involves terminating the plan. Another problem is how we can get the future wife to accept this estate plan prior to the marriage.

Answer: The plan this client wants poses a number of legal hurdles and income tax disadvantages. Perhaps there is a need to step back from these complications and look for a better way to accomplish his goals.

The plan he has in mind would require naming a trust as beneficiary of the retirement plan. The trust would provide that the wife would receive, each year, the income of the trust's non-retirement assets (if any), plus the "greater of" the minimum required distribution from the retirement plan for that year or the "income" of the plan for such year. Upon her death, the balance of the retirement benefits (if any are left) would pass to the client's children. This type of trust is called a "QTIP trust" (for "qualified terminable interest property"), a name derived from the Internal Revenue Code section dealing with marital deduction trusts.

If the trustee withdraws from the plan in any year more than the income/minimum distribution amount, the excess would be held in the trust for later distribution to the children.

While that sounds fairly straightforward, this proposed plan would have to clear numerous hurdles. After he and his family pay hefty legal fees to prepare and implement this plan, the client might then look down from heaven some years hence to see that his children receive exactly nothing from his retirement plans and his wife received much less than she could have received if things had been done a little differently.

Here are the obstacles to success with the QTIP trust plan; a suggested alternative approach at the end of this outline avoids these problems.

Federal spousal rights. Under federal law, once he and his new wife have been married for one year, he cannot designate anyone other than his surviving spouse as beneficiary of this plan unless she consents to allow him to name someone else. So, after the one-year period, he cannot leave his 401(k) plan to a QTIP trust without his spouse's consent. (Many retirement plans don't bother with the one-year waiting period; they give the spouse this consent right immediately upon the marriage.) This right cannot be waived in a prenuptial agreement, according to the Department of Labor. Having the spouse agree, in a prenuptial agreement, that she will later waive these benefits might work, especially if she is given a significant financial incentive to consent, but that outcome is not guaranteed.

Natalie Choate practices law in Boston, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is fast becoming the leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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