ESTATE PLANNING FOR THE BLENDED FAMILY:

Synergy or Disharmonic Convergence

FizerBeck
Fizer, Beck, Webster, Bentley & Scroggins
a professional corporation
1330 Post Oak Boulevard, Suite 2900
Houston, TX 77056-3022
713-840-7710
www.fizerbeck.com
 

Estate planning is a delicate balance of the personal wishes of the client and the laws of the state of domicile and the Federal government. However, the balancing act is elevated to a whole new level when the natural objects of the client's bounty are comprised of a second (or fifth) spouse, and the children from the client's current and prior marriage(s), as well as those children from the spouse's previous marriage(s). This educational presentation discusses the approach an estate planning professional might employ when working with a blended family and the spectrum of planning techniques that may be utilized. As with all such presentations, this cannot be taken as legal advice, and for the benefit of the IRS, is not a covered opinion subject to Circular 230.

1. Ambitious Assignment. One of the most challenging estate planning opportunities is working with clients who do not represent the nuclear family – the married couple with children only from their marriage – a so called "traditional family". Examples of non-nuclear families are couples with children from prior marriages and couples with no children but with collateral relatives (nieces and nephews) or elderly parents for whom a spouse wants to provide. For simplicity, the discussion will center around planning for the couple with children from prior relationships. The blended family clients have the same complicated tax issues as traditional families. However, traditional tax planning may not adequately address the intricate interrelationship issues present in many blended family situations. In such cases, the estate planning advisor has the ambitious assignment of educating the client(s) on the various issues, and proposing options to reduce the potential for friction between the surviving spouse and step-children while minimizing transfer taxes, all for a reasonable fee.

1. How to Approach Such Clients. First, carefully consider the situation. Paula J. Egner described it aptly when she said: "You're sure that the phrase 'Blended Family' was coined to conjure up a smooth and painless uniting of two families. But your experience feels more like frogs being dumped into the same blender in the hopes of extracting the prince of all step families."

1. Psychologically. Expect the topic of estate planning to be a very sensitive subject for the clients. The emotional and psychological trauma that caused the severance of the original family (or families), usually a death or a divorce, and the fusion of two families can have a significant and a continuing impact on your clients and their children. Accordingly, anticipate the blended family clients to have more life experiences (and unfortunately, some unpleasant ones) that will affect, and often impede, their decision making process in the estate planning arena. It is not atypical for one of the spouses to initially feel the intent of estate planning is to divide the assets and take away the financial security he or she desires. Lay the proper foundation for the clients by telling them that many couples struggle with the issues raised by having separate families. The estate planning advisor may have to serve as a mediator in these situations. As the advisor explains the options and considerations, he or she must be careful not to create any adversarial situations.

2. Defining Clients' Goals and Priorities. The main focus of the initial discussions is to clarify the clients' goals and priorities. These may include:

1. Caring for spouse and any children of the present marriage;

2. Providing for former spouse and/or children from a prior marriage;

3. Simplicity; and

4. Tax savings.

If either of the spouses has been divorced, the planner should inquire about any contractual obligations under an agreement incident to a divorce decree, and confirm that the former spouse is no longer a beneficiary of the client's estate (unless otherwise required by agreement). In most circumstances, if disposition documents were executed prior to divorce, a divorced spouse will not be a beneficiary of the former spouse's estate or an agent or fiduciary of the former spouse. See Tex. Prob. Code § 69 (for Will), Tex. Prob. Code §§ 471-473 (for management trust), Tex. Prob. Code § 485A (for power of attorney), Tex. Fam. Code § 9.301 (for insurance) and § 9.302 (for retirement plan), and Tex. Health & Safety Code § 166.155 (a)(3) (for medical power of attorney).

3. Explaining options. It is helpful to set forth the various options in a simple graph ranging from one extreme (all to spouse) to the other extreme (all to children). An example is attached at the back of the outline. This can serve as a template to which you can refer as the clients narrow their focus and specific techniques are selected.

4. Homework Approach. Unlike more routine planning situations, one interview is rarely sufficient for the clients to make final decisions (so plan your work and fees accordingly). In the first meeting the advisor typically discusses alternatives and requests the clients to take a few days to consider the options before directing the advisor to start drafting/implementing the plan. Further meetings may be necessary to discuss the various techniques, and to clarify the results the clients are seeking, as well explain the advantages and disadvantages of the final plan.

2. Ethical Issues. Unless each spouse had an advisor before the marriage, it is not unusual for a couple to jointly seek estate planning assistance. The first item the professional must assess is whether there is a conflict of interest between the two spouses, and if there is, determine if the conflict is an impediment to joint representation by the professional.

   An attorney shall not represent a client if the representation of that client will be directly adverse to another client unless the attorney reasonably believes one representation will not adversely affect the other, and both clients consent after consultation, that is confirmed in writing. When representation of multiple clients in a single matter is undertaken, the consultation shall include an explanation of the common representation and the advantages and risks involved. Rules 1.06 and 1.07 of the Texas Disciplinary Rules of Professional Conduct. Other professionals are covered by similar restrictions that are imposed by the licensing group or as a creed of an association.

   Clearly, there is the potential for a conflict of interest in dealing with the various needs and wishes of blended families. In fact, in such situations the estate planning advisor is obligated to educate the husband and wife regarding these conflicts and/or potential conflicts. In some cases the conflict is such that the professional must withdraw from or decline the joint representation.

   Assuming there is no ethical violation, in some instances the clients may be better served when represented by the same estate planning professionals who have an overall understanding of the family's entire situation and who can coordinate the various components of the estate plan. In such cases, if the professional proceeds with a joint representation of the husband and wife, the professional should clearly disclose the potential conflicts at the outset, advise the clients of the ramifications of the conflicts, and remain vigilant should the need to withdraw arise. See ACTEC Commentaries on the Model Rules of Professional Conduct (Third Edition, March 1999). For examples of engagement letters, see the ACTEC website.

   For attorneys, the clients particularly need to understand that once the attorney undertakes to represent both husband and wife, then neither spouse can have discussions relative to the matter that will be held "confidential" from the other spouse by the attorney. The duty to lay out advantages and disadvantages of a proposed plan to both spouses when there is joint representation should be made clear.

   If the attorney has represented the parents or children of one of the spouses, a consent of all current and potential clients who are related should be obtained. Typically the consent will describe how attorney-client information will, and more importantly, will not be shared among the parties, and require waiver of the obligation to disclose information obtained by one client that might be detrimental to another. If a consent was previously agreed to, it may be necessary to obtain a new consent if your proposed representation includes a "new spouse." There will be occasions where it is more prudent to refuse the acceptance of a new client even though all parties are willing to consent. Don't be reluctant to say "no" when your instincts tell you to walk away.

2. COMMON CONCERNS. The planning solutions for blended families are more often fact specific than for nuclear families, but both groups have many of the same legal issues in common.

1. Marital Property Rules. Clients are typically unfamiliar with the rules regarding the classification of marital property. It is necessary to educate the clients on these rules in order for each to understand the property each owns and controls. If the couple is not married, the option of a premarital agreement, or if married, a marital agreement should also be discussed.

1. Separate Property. A spouse's separate property consists of: (i) property acquired before marriage; (ii) property acquired while living outside a community property jurisdiction; (iii) property acquired after marriage by gift or inheritance; (iv) property contractually agreed to by the spouses to be separate property; and (v) recovery for personal injuries (excluding recovery for loss of earning capacity). Tex. Fam. Code §§ 3.001, 4.003 and 4.102.

2. Community Property. A spouse's community property consists of property, other than separate property, acquired by either spouse during marriage. Tex. Fam. Code § 3.002.

3. Community Presumption. In order to solve title problems when accounting information is unavailable, Texas law presumes that all property owned by husband and wife is community unless it is established otherwise. This presumption can be overcome by "tracing" the property acquisition to a separate property source. The burden of proving an asset is separate property is on the party asserting that the asset is separate property. The separate property characterization must be established by clear and convincing evidence. Tex. Fam. Code § 3.003. If separate and community property assets have become so commingled that it is impossible to trace accurately, then the presumption operates to make the assets community property. Accordingly, the separate property character of assets can be lost if accurate records are not maintained.

4. Appreciation. There are special rules regarding the characterization of the income earned on and the capital appreciation of separate property.

1. Increase. If a separate property asset increases in value, this enhancement remains separate property. For example, land owned before marriage remains separate even though the value of the land increases during marriage.

2. Income. Unlike the rules regarding capital appreciation, the income derived from separate property assets is generally community property (absent contrary agreement between the spouses). Accordingly, community property includes such items as cash dividends from separate property stock, rent from separate property land, and interest from separate property accounts. Until 1980, the Texas Constitution did not permit spouses to alter these income rules. After the amendment in 1980, income derived from separate property may remain separate if the parties agree in a formal written document. Further, if the separate property is created by a partition and exchange agreement, Section 4.102 of the Texas Family Code (as amended in 2005) permits the spouses to "provide that future earnings and income arising from the transferred property shall be the separate property of the owning spouse" in the partition and exchange agreement. Previously, the presumption was income from the portioned and exchanged property was separate, unless agreed in writing by the spouses to be community.

5. Inception of Title. Under the "inception of title" doctrine, the characterization of property is determined at the time the property is acquired. Accordingly, separate property does not become community by virtue of subsequent marriage or relocation to Texas. However, in a divorce proceeding, separate property acquired by the spouse in a common law state that would have been community in Texas, can be subject to equitable division by the Court. Tex. Fam. Code § 7.002. There is not a comparable provision in the Texas Probate Code.

6. Claims and Rights. If community funds are used to make payments on a separate property secured debt (such as a mortgage), or to make improvements on separate property, the community does not acquire an interest in the property. However, upon dissolution of a marriage by death or divorce, the community may be compensated for the use of community funds that enhanced the separate property of one spouse (statutory claim for economic contribution). Tex. Fam. Code §§ 3.402 and 3.403. Similarly, if community funds are used to make payments on unsecured debt benefiting a spouse's separate property, the community has an equitable claim of reimbursement. Tex. Fam. Code § 3.408. Statutory and equitable claims are also applicable when separate property is used for the benefit of the community estate. Funds used for: (i) child support, (ii) alimony, (iii) living expenses of spouse or child of spouse, (iv) contributions and payments of nominal value, (v) spousal maintenance and (vi) payment of student loans are not reimbursable. Tex. Fam. Code § 3.409.

7. Proceeds. If separate property is sold, assets acquired with the sale proceeds generally remain separate property. For this purpose, it is essential that the source of funds be specifically traced to a separate property origin.

8. Tracing Issues. If a spouse has separate property assets as well as community property assets, the asset characterization may become very important upon the death of a spouse. By definition, the surviving spouse is always entitled to his or her one-half share of the community. If a father leaves his assets to his children upon his death, for example, the children will receive his separate property and his one-half of the community property. Assuming the absence of a marital agreement, tracing will have to occur to establish what is separate property and what is community property. If careful records were not kept and the marriage was a long one, tracing may prove to be very difficult, if not impossible.

9. Marital Agreement. Marital agreements are often thought of as being tools in the divorce or family law attorney's arsenal. However, estate planners can utilize marital agreements to facilitate the estate plan in a blended family situation. Clients should be urged to enter into marital agreements if the spouses intend to leave their assets other than to each other and if tracing issues might arise. Marital agreements typically involve an agreement to convert community property to separate property. Texas Family Code § 4.102 allows spouses to partition or exchange community property between themselves in order to characterize the property as one spouse's separate property. For example, the spouses may agree that any income from separate property assets (which would otherwise be characterized as community property) remains the separate property of the spouse owning the asset. Explain to the clients how marital agreements can alleviate post-death tensions by setting forth asset characterization in a way that will not be subject to dispute upon the death of one of the spouses. Unless the agreement is primarily for estate planning techniques such as creating separate property to make gifts to an insurance trust that the other spouse is a beneficiary, both parties should have separate representation.

10. Conversion of Separate Property to Community Property. Effective January 1, 2000, spouses (not persons planning to marry) may also agree that all or part of the separate property owned by either or both spouses is converted to community property. Tex. Fam. Code § 4.202. The requirements of such an agreement are set forth in Section 4.203 of the Texas Family Code.

1. Advantages:

1. minimizes tracing issues and potential conflicts between the surviving spouse and the children of the decedent regarding characterization of property (community v. separate); and

2. receive step-up in basis for the entire community on death of the first spouse.

2. Disadvantages:

1. entire community becomes subject to equitable division upon divorce; and

2. entire community is reachable by both spouses' creditors except as precluded by law (see Tex. Fam. Code § 3.202).

2. Intestate Succession. If a person dies without a Will, he or she is said to have died "intestate." Under such circumstances, Texas law directs distribution of the property. In the typical situation where a person dies without a Will and is survived by a spouse and children, the estate will pass under the Texas laws of descent and distribution as follows:

1. Separate Property. The surviving spouse will receive one-third of the separate personal property and a "life estate" in one-third of the separate real property of the deceased spouse. The balance of the separate property of the deceased spouse will pass to the deceased spouse's children. Upon the surviving spouse's death, the life estate property automatically passes to the children of the deceased spouse. Tex. Prob. Code § 38.

2. Community Property. If the children are all from the decedent's present marriage, then the community estate passes to his or her surviving spouse. If the decedent's children are not all from the present marriage, the surviving spouse retains his or her one-half interest in the community property, but the deceased spouse's entire one-half interest in the community property passes to his or her children. Tex. Prob. Code § 45.

3. Homestead. Notwithstanding our inheritance laws, the surviving spouse has the right to continue occupying the residential homestead. However, this right expires if the surviving spouse ceases to occupy the homestead. Vernon's Ann. Const., Art. 16 § 52.

3. Post-Death Management Issues. Frequently it is the clients' desire that, when one spouse dies, the assets shall be left in trust for the lifetime benefit of the surviving spouse with the remainder to be distributed to the descendants of the first spouse to die. This approach can result in a variety of management issues. These issues are discussed further in Article III below.

4. Estate and Gift Taxation. Our tax system imposes a tax on the transfer of assets, whether made during life (gift tax) or at death (estate tax). Estate and gift taxes are unified under one rate schedule. All transfers of a taxpayer are added together to determine the ultimate tax liability. Significant changes were made to the estate and gift tax system by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that President Bush signed into law on June 7, 2001. It is important to understand estate planning prior to EGTRRA before one can appreciate the full impact of EGTRRA.

1. Exclusions and Deduction. Central to the law before and after EGTRRA is the utilization of transfers that escape taxation or the taxation is deferred. The annual gift tax exclusion permits a taxpayer each year to give to each of any number of persons, property equal to or less than a specified dollar amount. This exclusion is referred to in this outline as the "annual exclusion". Section 2503 of the Internal Revenue Code of 1986, as amended (the "IRC"). The second type of tax-free transfers is the applicable exclusion amount that is the sum of assets that the taxpayer can give away during lifetime and/or at death. This exclusion is sometime called the "unified credit exclusion amount", the "exemption amount" or the "sheltered amount," but for this outline, it will be referred to as the "tax-free amount". Section 2010 of the IRC. The third favored technique, the marital deduction, does not allow a tax-free transfer, but rather deferral of taxation to a later date. The marital deduction excludes from taxation transfers to a spouse during the taxpayer's life or at his death, as long as the recipient spouse is a U. S. citizen and the property passes to the spouse in a qualifying manner (generally outright or to a specific type of trust). Because there is no restriction as to the amount, just the manner in which assets may be transferred, this transfer is often referred to as the "unlimited marital deduction", as it will be in this outline. IRS § 2056. A marital deduction for estate tax purposes is allowed for a surviving spouse who is not a U.S. citizen if the requirements of §§ 2056(d) and 2056A of the IRC are met. There is no marital deduction for taxable gifts to a spouse not a U.S. citizen. IRC §§ 2523(i) and 2503(d).

2. Estate and Gift Taxes Prior to EGTRRA.

1. Estate and Gift Taxes. On January 1, 2001, the tax-free amount was $675,000, an increase from the $600,000 tax-free amount implemented in 1986, and was scheduled to gradually increase to $1,000,000 in 2006. The annual exclusion was $10,000 per recipient, and was subject to increases due to inflation by $1,000 increments. Once the tax-free amount was exhausted, taxes were imposed at a rate beginning at 37% and increasing to 55% (60% for very large estates).

2. Capital Gains Tax. When an asset is sold, the taxpayer recognizes a taxable gain or loss, measured by subtracting the basis of the property sold (usually the cost of the property) from the sales proceeds. In the case of inherited property, the decedent's basis in an asset is increased (or decreased) to the fair market value of the property at the date of death. IRS § 1014. This is often referred to as the "step-up" in basis and has the effect of erasing virtually all capital gains on inherited property. In contrast, the basis of a gift is not stepped-up to its fair market value at transfer (except to the extent gift tax is paid) and instead, the recipient's basis in the gift is the basis of the transferor (and accordingly is known as the "carry-over basis").

3. Estate and Gift Tax After EGTRRA.

1. Estate and Gift Taxes. On January 1, 2002, the estate and gift tax-free amount increased from $675,000 to $1 million. For gift tax purposes, the tax-free amount remains at $1 million. For estate tax purposes, the tax-free amount increased to $1.5 million in 2004, to $2 million in 2006, and will increase to $3.5 million in 2009. In addition, the top estate and gift tax rates were initially decreased to 50%, and then gradually decreased by one percentage point per year beginning in 2003 until the rate reached 45% in 2007.

   In 2010 estate taxes are repealed, subject, however, to the "sunset provision" discussed below. Beginning in 2010 gifts in excess of the $1 million tax-free amount will be taxed at the top federal income tax rate, which is scheduled to be 35% at that time.

   Annual gifts of up to $10,000 (indexed for inflation) per recipient may be made without using any of the tax-free amount. As of 2007, the annual exclusion is $12,000. In addition, until complete repeal of the estate tax, all qualified transfers to a spouse who is a U.S. citizen remain tax deferred and are included in the spouse's estate for tax purposes.

2. Capital Gains Taxes. EGTRRA substantially limits the step-up in basis rule. Beginning in 2010, persons who inherit property will have a "carryover basis" equal to the decedent's basis or the value at date of death, whichever is less. However, an estate will be allowed to "step-up" the basis of up to a total of $3 million in assets transferred to a spouse and up to a total of $1.3 million in non-spousal transfers, for a total of $4.3 million. IRS § 1022. This will require additional record keeping and reporting compliance.

3. Sunset Provision. EGTRRA contains a "sunset" provision that causes most of the provisions of the 2001 Act law to disappear and the law before EGTRRA to once again take effect on January 1, 2011, barring Congressional action to renew the Act. Since the law could be altered at any point over the next few years by a new President or a new Congress, many commentators believe that we will never actually see full repeal of the estate tax.

5. Second Generation Planning. Typically, a Will might provide that assets be held in trust for the children until a specified age or ages. At the designated time, the trust assets are often distributed outright to the children. It may be more advantageous not to make outright distributions to the children, but rather to allow the children to inherit their assets through a lifetime trust arrangement.

1. Provisions. A typical child's trust contains flexible distribution provisions.

1. "HEMS." Distributions are permitted for health, support, maintenance and education of the child and the child's descendants. Treas. Regs § 20.2041-1(c)(2). In addition to such standard, the trust may restrict distributions under certain circumstances, so called "incentive" provisions.

2. "Power of Appointment." The child is usually given a "power of appointment" to direct disposition of the trust assets at death.

1. Control – The trust structure is not always intended to eliminate a child's control of the trust assets. The child may be given powers of appointment to direct who will receive the assets remaining in the trust at the child's death.

2. Restrictions – If the parents want to control the ultimate distribution of trust assets, the power of appointment can be eliminated or restricted.

3. Special Power of Appointment – To fully utilize the testator's generation-skipping transfer tax ("GST Tax") exemption (discussed below in this section E), the trust should not give the child power that will cause the assets to which the GST Tax exemption was allocated be included in the child's estate. The child may be given a special power of appointment, restricted to the extent necessary to preclude the assets subject to the power from being included in the child's taxable estate. The granting of such power gives the child the flexibility to name who will receive the assets at his death, similar to outright ownership, but without subjecting the assets to the estate tax at the child's death. For example, the child could have a power to appoint to such individual or individuals or charity or charities other than the beneficiary, the beneficiary's creditors, the beneficiary's estate or creditors of the beneficiary's estate.

2. Control. Although the children inherit their assets in trust, they can still be given control at an age specified in the Will (or Trust Agreement). The child may be allowed to become the trustee of his or her trust. Often this is done in stages, allowing a child to become co trustee at a given age (25 or 30 years), and sole trustee at a later date (30 or 35 years). The two stage arrangement gives a child some management "practice" as a co trustee, before giving the child sole management responsibility. Management or management assistance may be continued during a child's lifetime if a child cannot manage assets.

3. Advantages. The advantages of a lifetime trust arrangement, as opposed to outright distribution, are as follows:

1. Creditors. Although the child can control the assets as trustee, the trust property generally cannot be reached by claims of creditors or jurisdiction of a divorce court.

2. Distributions. During the life of the child, the trust can permit distributions to grandchildren, who may be in lower income tax brackets than the child. (Note: for trust beneficiaries under age 19 or a full-time student under the age of 24, the advantages of income shifting are restricted by rules which tax most of a child's unearned income at the parents' rate. IRS § 1(g).

3. Assistance. Management assistance can be provided for a child until a designated age, or for lifetime if needed (or warrantied).

4. Tax Planning. At the child's death, a portion of the trust assets can escape taxation upon passage to the third generation by use of the donor's GST Tax (generation-skipping transfer tax) exemption. IRC § 2631.

1. General Rule – Under the Tax Reform Act of 1986, a "GST Tax" is imposed on transfers from a donor to a donee who is two or more generations from the donor, either directly or through a second generation trust. IRC §2601.

2. Amount – Each person has an exemption from the GST Tax of $2 million effective for years 2006-2008, and scheduled to be $3.5 million in 2009. Accordingly, a married couple in 2008 can place approximately $4 million in trust for their children, and the entire $4 million (plus growth) escapes transfer taxation when the trust assets ultimately pass to the third generation.

3. Doubling-up – If property passes outright to the children, it will be fully subject to estate taxation in the second (child's) generation.

4. Future Beneficiaries – The use of second generation trusts to avoid the GST Tax does not require the grandchildren to be in existence at the death of grandparent or creator of the trust.

5. Powers of Appointment – To maximize the allocation of the decedent's GST Tax exemption the child may be given a special power of appointment to direct the use of the assets after his or her death without causing the assets to be taxed in the child's estate. For assets in trust that are not exempt from GST Tax, a general power of appointment can be given to a child/beneficiary of the trust who has children so the assets will only be subject to the estate tax in the child/beneficiary's estate rather than the higher rate when the GST Tax applies.

3. PLANS FOR THE BLENDED FAMILY. One of the typical scenarios of a blended family is where each spouse has children from a prior marriage or marriages. Admitting that there is a plethora of planning options to choose from, the following discussion focuses on five approaches and the advantages and disadvantages of each. The key characteristics of each approach is compared in the spread sheet attached.

1. All Outright To Spouse. Simple to understand and implement, the gift of all of the estate of the first spouse to die (sometimes referred to herein as the "testator" and for simplification in their outline, will be presumed to be the husband, and the surviving spouse, the wife), to the surviving spouse is the first option for the blended family. Not surprisingly, it is also the result some clients mistakenly think will happen if they do not have a Will.

1. Advantages.

1. Simplicity. The disposition provisions to implement this plan are short and easy to understand. No need for lengthy formulas or tax provisions. There are no difficult decisions or elections required of the fiduciary of the estate.

2. No tracing issues. The community property and separate property characterization issues become irrelevant. Despite the property's characterization, it all passes to the surviving spouse.

3. No accountability. The surviving spouse does not have to "answer" to the children of the testator. The surviving spouse has unilateral control over all assets and may do whatever he or she pleases. Thus, the testator's children have no expectancy of an inheritance upon the surviving spouse's death. This may be the best course of action in the situation in which inter-family problems are certain to develop in the future, in spite of any negative tax consequences as a result of not taking advantage of the testator's tax-free amount.

2. Disadvantages.

1. Potentially Increases Tax Burden. If everything passes outright to the survivor, the testator's tax-free amount is wasted. The sum of the testator's estate and the surviving spouse's assets will be taxed for estate tax purposes with only the surviving spouse's tax-free amount available.

2. Surviving spouse has total control. There is no guarantee that the surviving spouse will not completely revise his Will that represented the arrangement both spouses agreed to before the first death, and eliminate the deceased spouse's children as beneficiaries of the surviving spouse's estate. However, see § 59A of the Texas Probate Code regarding contracts concerning succession and § 4.003 of the Texas Family Code regarding premarital agreements.

2. All Outright To Children. Again, simple to draft and understand, but the reality of the disposition may be difficult for the surviving spouse mentally and financially.

1. Advantages.

1. Simplicity. As with the gift to the surviving spouse in Section A above, this plan is easy for the clients to read and understand.

2. No accountability. Neither side is answerable to the other. The surviving spouse takes his one-half of the community property and her separate property. The children take the testator's one-half of the community property and all of the testator's separate property. The surviving spouse and the children have separate and distinct assets, and they are not "tied" to the other, except where partition of an asset was not possible or practical. However, having the children and spouse jointly own an asset is sometimes better than where the children have a successive interest following the surviving spouse's life estate interest.

3. Inheritance ensured. There is no risk that the testator's children will not inherit his assets.

2. Disadvantages

1. Marital property issues. If there is no prenuptial or marital agreement in place, there may be tracing issues related to the identification of the community property and the separate property. Due to the presumption of community property status in the law, it may be difficult to establish which assets are the testator's separate property.

2. Homestead right. The surviving spouse is entitled to occupy the homestead as long as he or chooses. Tex. Prob. Code § 284. If the testator's children (or beneficiaries other than the children) inherit all or an interest in the homestead property, these must be a division of expenses, and repairs and resolution of other ownership issues between the surviving spouse and the successors to the deceased spouse's interest.

3. Other spousal rights. The surviving spouse has other "spousal" rights under the law that might cause the testator's estate to make some allowance payments to the surviving spouse. If the testator did not own a homestead, the surviving spouse is entitled to up to $15,000 in lieu of homestead and up to $5,000 in lieu of exempt property. Tex. Prob. Code § 273. In addition, the surviving spouse is entitled to an allowance sufficient for her maintenance for one year upon a showing that she has inadequate separate property for her support. Tex. Prob. Code §§ 286-288.

4. Tax consequences. If the testator's estate is in excess of the tax-free amount, estate tax will be due since such excess does not qualify for the marital deduction.

5. Qualified plans. Under the Retirement Equity Act of 1984 ("REA"), the non-participant surviving spouse must agree to any beneficiary designation implemented by the participant that does not name the spouse as the primary beneficiary. A surviving spouse (and other non-spouse beneficiaries under the Pension Protection Act of 2006) is able to "roll-over" the qualified plan into an IRA in her name and to receive the continued income tax deferral. Care must be taken in the drafting of a beneficiary designation that names anyone other than the surviving spouse to ensure the designation is valid under REA, and that the tax consequences (estate and income) will be as expected. Note: By law, beneficiary designations for IRAs do not require the non-participant spouse's written approval, but most custodians insist upon it anyway. However, the participant is required to have the written approval of the spouse to roll-over a qualified plan into an IRA.

6. Outright v. in trust. The simplicity of making the gifts to the children outright must be weighed against the benefits afforded by a trust:

1. management assistance;

2. protection from creditors;

3. limit accessibility of spouse of child; and

4. possible exclusion from child's taxable estate by allocation of testator's GST Tax exemption.

3. Blended Plan. This plan is a combination of the first two options. Some assets are given outright to both the spouse and the children of the testator.

1. Advantages.

1. Psychological. Testator demonstrates to the spouse and the children that they are important to him and that the testator cares about their welfare. Testator does not feel like he has left anyone out of the estate, and has the peace of knowing his children received some of the assets after the testator's death, rather than depending on the generosity of the surviving spouse to make bequests to the testator's children.

2. Tax planning. The portion of the testator's estate that passes to the surviving spouse qualifies for the marital deduction, so the transfer tax on that portion of the estate is deferred until the surviving spouse's death. The gift to the children can be exempt from estate tax to the extent of the tax-free amount remaining at the testator's death.

3. Freedom. The surviving spouse and the testator's children are not tied to each other, after partition of the assets, with regard to their inheritance from the testator.

2. Disadvantages.

1. Tracing. If there is not a marital agreement, there may be tracing issues related to the testator's separate property assets. However, the gifts can be drafted in one of two ways to address this potential problem.

1. Reducing Gift - The testator can make a bequest to his surviving spouse reduced by the spouse's share of the community property. In this scenario, the identity of community property and separate property becomes meaningless, as the surviving spouse will receive the same amount of property regardless of the characterization of the assets.

2. Specific Gift - The testator may gift specific assets or specific amounts to the children with the remainder to the surviving spouse. This should also minimize the need of the fiduciary to trace the characterization of the assets as separate and community.

2. REA compliance. The testator must acquire the signature of the spouse if he wants (or needs) to give any portion of a qualified plan to someone other than the surviving spouse. As discussed above, complying with REA and the related statutes and regulations can be problematic.

3. Homestead and other spousal rights. Same concerns as discussed above in Section B.

4. Tax issues. It is important to analyze how the testator's tax-free amount is utilized under this plan (for example, applied to the gifts to the children). If the client makes a gift of the tax-free amount, he or she should be aware that under EGTRRA, this amount is increasing over the next few years and may ultimately be the entire estate upon repeal of the estate tax (in 2010, under current law). Accordingly, a client (and his or her attorney) must be very careful to consider this reality and possibility when drafting the estate plan. Likewise, the manner and amount of the unlimited marital deduction must also be carefully considered and analyzed to confirm that the testator's plan will have the tax results intended. Finally, tax apportionment is a critical component of this estate plan and must never be left to the scrivener's boilerplate provision. Failure to calculate the effect the tax apportionment clause will have on the gifts under the testator's plan can cause undesired or unintended consequences.

3. Other Planning considerations.

1. Survival clauses. The drafter must check the survival clauses in the couple's Wills to ensure that the application of the clauses will not result an unintended consequence in the event of the couple's simultaneous death.

2. No contest provisions. No contest clauses are particularly important in the context of a blended family and may prevent family discord and litigation. One version might permit the executor to "forgive" a beneficiary if a contest was filed but is later withdrawn within 30 days of filing. The grace period would give a beneficiary an opportunity to re-think his original decision to contest the Will, and hopefully allow the beneficiary to receive the gift intended by the testator if the lawsuit is withdrawn. Allowing the executor this altitude could minimize litigation.

4. All In Trust to Spouse, Then To Children. This variation on the theme of taking care of the surviving spouse, does it in a manner that potentially preserves a portion of the estate for the testator's children after the surviving spouse's death. The testator may leave his assets in a bypass trust and/or a QTIP trust for the surviving spouse's lifetime benefit. At the death of the surviving spouse, the assets in the trusts will pass to the children as remainder beneficiaries. One issue that must be addressed in this plan is whether the remainder beneficiaries in each spouse's Will will be their respective children, or the children of both spouses. The clients must understand that if the children of both spouses are included in the Will of the first spouse to die, the surviving spouse might later change her Will to only include her children as beneficiaries of the estate thereby causing an unequal division of the spouse's estate among all of the children.

1. Advantages.

1. Beneficiaries. The testator can arrange for the care of the surviving spouse for her lifetime and also ensure (if surviving spouse only has an income interest in the trust) that the testator's assets will pass to his children at the surviving spouse's death.

2. Tax advantages. The testator can protect his tax-free amount from estate tax by giving an amount equal to such exemption to the bypass trust created under the testator's Will. The balance of the testator's estate can pass to the QTIP trust, thus taking full advantage of the unlimited marital deduction. The testator can allocate his GST Tax exemption to the bypass trust, and any balance, to the QTIP trust making a reverse QTIP election. Because the QTIP trust is included in the surviving spouse's estate, a portion of the surviving spouse's GST Tax exemption may (at the election of the surviving spouse's executor) be allocated to the QTIP trust at the surviving spouse's death, which if such trust passes to the testator's children, will increase the amount exempt from taxation in the estate of the testator's children.

3. Creditor protection of assets. Assets that the testator leaves in spendthrift trusts are protected from creditors of the beneficiaries.

4. Alternative to outright. Making a gift in trust is an alternative to an outright gift while maintaining the essential element of enjoyment by the surviving spouse. The testator can expand the surviving spouse's control by granting the surviving spouse a special power of appointment over the trust. (Reminder: If the trust is a QTIP trust, the power can only be a testamentary power. If the trust is funded with the testator's tax-free amount, then the power may be exercisable during life and/or at death.) The power of appointment ensures that no remainder beneficiary has a vested interest in the trust. Hopefully, this will deter any of the testator's descendants from creating problems for the surviving spouse. If problems surface, the surviving spouse has the ultimate ability to cut out one or more of the "difficult children." The special power may be limited to the testator's descendants and/or may include charities or other individuals in the class of potential appointees, but should prohibit the surviving spouse from appointing the trust in favor of herself, her creditors, her estate or the creditors of her estate.

2. Disadvantages.

1. Adverse beneficiaries. The surviving spouse will be the beneficiary (of income and possibility principal) for the spouse's lifetime while the children will be remainder beneficiaries, subject to any power granted to the surviving spouse. Anything distributed to the surviving spouse will, by definition, mean such assets are not available for later distribution to the children. Accordingly, a trust situation creates an inherent conflict between the surviving spouse and the remainder beneficiaries. If there is family friction before or at testator's death, a trust situation, particularly with discretionary distribution provisions, could easily exacerbate the tension. The testator may choose to add language directing liberal distribution of the principal of the trust in order to thwart the remaindermen from questioning such discretionary distributions.

2. Accountability of trustee. Due to the inherent conflict mentioned above, the trustee may face difficult distribution decisions weighing the rights of the current income beneficiaries and those of the remaindermen. Conflicts may be even more pronounced if the surviving spouse is designated as the trustee of such trusts. Thoughtful consideration must be given to the selection of the trustees in this situation.

3. Investment issues. In a QTIP trust, the surviving spouse is entitled to all income, payable at least annually for life. Accordingly, the surviving spouse will prefer the trust be invested in income producing assets. On the other hand, the remainder beneficiaries are more interested in growth assets. The trustee must balance the desires and interests of the income beneficiary with those of the remainder beneficiaries, while complying with the Uniform Principal and Income Tax Act and the Uniform Prudent Investor Act, if applicable under the terms of the instrument. Tex. Trust Code Chapters 116 and 117. See the discussion in section D.3. below.

4. Delayed inheritances for children. Depending upon the age of the surviving spouse, the children may not receive their inheritance at a point in their lives that the gift will be useful to them. For example, if a man marries a woman who is significantly younger, his children may inherit very late in their lives (or not at all).

3. Special issues with the QTIP trust.

1. Income only v. principal distribution. A QTIP trust must provide that the surviving spouse receive all income for life. However, the trust may also provide that mandatory or discretionary distributions of principal are made to the surviving spouse. The testator must decide what is his intent with respect to providing for the surviving spouse. The more discretion given to the trustee, the more potential for tension in the family.

2. Unitrust concept. In response to the issues that arise over the investment strategy employed by the trustee, the testator may incorporate the payment provision of a unitrust in the QTIP trust. As a result, the trust may be designed to give the surviving spouse the greater of all income each year or a specific percentage of the trust assets on an annual basis (the "unitrust amount"). See Tex. Trust Code § 116.007, IRC Reg. § 1-643(b)-1 and PLR 200702013. The purpose of a unitrust is to encourage a unified investment strategy. With a unitrust, all beneficiaries (income and remainder) benefit from the overall growth of the trust. Thus, the benefit of investment in growth assets also inures to the benefit of the surviving spouse.

3. Trusteeship choices. The choices for the trustee are (i) the spouse, (ii) a child or children, (iii) a third party or corporate trustee, or (iv) two or more of the foregoing.

1. If the surviving spouse is the trustee, her distribution decisions regarding her needs as a beneficiary as well as the decisions regarding the investment of the trust may draw scrutiny by the remainder beneficiaries.

2. If the children are named the trustees of the surviving spouse's trusts, there will be similar problems as those faced when the spouse is named as the trustee. Potentially, all decisions, elections or omissions of the beneficiary/trustee (income or remaindermen) are likely to be criticized in an attempt to find fiduciary liability.

3. Having an objective third party trustee may be appealing to avoid putting a spouse or children in a difficult situation. However, the third party may not be willing to step into a difficult family situation. A trust with clearly defined distribution provisions (less discretion) and more investment flexibility (perhaps a unitrust approach) would be more appealing to a third party trustee.

5. Part in Trust to Spouse, Some to Children at Testator's Death. Rather than require the children of the testator to wait until the death of the surviving spouse, the testator could plan to give (in trust or outright) a portion of his estate to the testator's children at death. Before the applicable exemption amount started its climb in 1997, the tax-free amount was $600,000. Now that the tax-free amount is spiraling upwards to $3.5 million, extreme care must be taken in drafting around the use of the tax-free amount in order to meet the expectations of the surviving spouse and the testator's children.

1. Advantages.

1. Tax advantages. The testator can take advantage of some or all of the tax-free amount by giving property to the children immediately upon his death. The remainder of the exemption, if any, can pass to a bypass trust to ensure that the entire tax-free amount is utilized, benefiting the surviving spouse and/or the testator's children. Again, one must be careful to consider the impact of the increasing tax-free amount under EGTRRA when drafting a plan which is tied to a testator's exemption.

2. Immediate satisfaction of children. This plan prevents putting the testator's children in a position where they are "waiting" for the surviving spouse to die before they receive any of their inheritance. Hopefully, this will prevent the children from scrutinizing the distributions and management of the trust for the surviving spouse.

2. Disadvantages. The disadvantages of creating a trust for the surviving spouse are basically the same as those found above in Section D, when all of the testator's assets are left in a trust for the surviving spouse.

6. Life Insurance as a Solution. Irrespective of the testamentary plan (assets passing outright or in trust), life insurance can provide an effective means of providing for one or more of the parties. For example, if the assets are to be held in a trust for the surviving spouse, life insurance can be purchased in a trust for the testator's children in order to provide funds for the children at the testator's death. If the insurance trust is drafted with withdrawal rights, all or a portion of the gifts to the trust may qualify for the donor's annual gift exclusion. Further, the testator may elect to allocate GST Tax exemption to the trust, (or the trust may be subject to the so-called "deemed allocation" rules of IRC § 2632 (c)) so the trust can continue for future generations, subject to the rule against perpetuities, without transfer tax. As an alternative, the insurance policy could benefit the surviving spouse outright or in trust, thereby allowing the testamentary assets to pass to the testator's children. Use of insurance in this manner is especially effective when the testamentary assets include a family business.

1. Advantages.

1. Immediate benefits – The surviving spouse is provided for, and the testator's children receive assets without waiting until the surviving spouse's death.

2. Tax efficiency – The annual exclusion may cover all or a portion of the gift necessary to cover the premiums, leveraging the tax-free amount. The marital deduction can be utilized to defer taxation of proceeds that are includable in the testator's estate. If GST Tax exemption is allocated as gifts are made to a trust owning life insurance, a smaller amount of the GST Tax exemption is required to protect the policy proceeds in comparison to the allocation of GST Tax exemption to the same proceeds at the testator's death.

3. Eliminate tracing - If the testator uses separate property to make the gifts, and in most cases he should, then at the testator's death, there should not be any characterization issues.

4. Non-probate asset – Insurance is paid in accordance with the beneficiary designation, not the Will of the owner (or the insured). This feature eliminates the proceeds from being subject to administration of the testator's estate before the beneficiaries receive the gift. However, if there is no beneficiary named, the terms of the insurance contract may dictate that the proceeds be paid to the owner's estate or the insured's estate, in which case the Will is a factor.

2. Disadvantages.

1. Cost of insurance – Factors that dictate the premium for the policy include the age, sex and health of the insured, the type of policy (term, whole, universal, etc.) and the rating of the company issuing the policy. While it appears that the industry has a policy available for everyone, the purchaser must determine if the cost of such policy is worth the benefit.

2. Irrevocable –  The policy must be irrevocably assigned in order to excluded the proceeds from the insured's taxable estate.

3. Paperwork – In order to avoid the three year inclusion rule the insured should never own the policy, permitting the intended beneficiary (individually or the trustee of a trust) to apply for the coverage. Additionally, the beneficiary designation must be properly completed and filed by the owner. If gifts for the premiums are to be paid with only separate property of the insured spouse, records regarding the character of the funds must be retained (partition agreements, checks, etc.). Additionally, if the policy is owned by a trust, records of the notices to the beneficiaries should be retained to establish that the donor was entitled to use his annual gift exclusions for all or a part of the gift to the trust. It is conceivable that an insurance trust will exist for a long term, so the trustee must be committed to complying with the terms of the trust and maintaining the records. If an insurance trust has not been maintained as it should in order to achieve the tax goals of the grantor, investigate techniques for repair.

4. IRAs and QUALIFIED PLANS. Often the participant of a qualified plan or owner of an IRA wishes to have the benefits payable to a QTIP Trust so that the surviving spouse may have access to the funds for her lifetime, and direct any assets on hand upon the surviving spouse's death to the participant's descendants. This raises a variety of issues. Due to the complexity of this area, this outline does not offer a comprehensive discussion, but rather only highlights a few key issues in relation to planning with the blended family. Please refer to Natalie Choate's book, Life and Death Planning for Retirement Benefits (6th ed. 2006) for a detailed explanation of this topic. (Note: for purposes of this section, and except as specifically noted, IRAs and Qualified Plans are treated in the same manner and the terms are used interchangeably.)

1. REA. The Retirement Equity Act of 1984 ("REA") governs certain plans and benefits subject to ERISA. REA requires consent of the participant's spouse in order for the participant to designate a beneficiary other than his or her spouse. This would include designating a QTIP Trust as the beneficiary. Obviously, this could pose an obstacle in implementing the participant's plan. This particular restriction is not applicable to IRAs, but it seems that many custodians nonetheless require the consent of the spouse in all cases in which the spouse is not named as the beneficiary.

2. Marital Deduction Planning. To the extent property passes to a QTIP Trust, the trust must satisfy the requirements of Section 2056(b)(7) of the IRC at the participant's death in order to postpone any estate taxes which would otherwise be due upon such property at the participant's death.

   For a time there was concern as to whether IRA benefits payable to a QTIP Trust satisfied the QTIP Trust's mandatory income distribution requirement. This concern was raised by Rev. Rul. 89-89, 1989-2 C.B. 231. In the facts of this ruling, the IRA beneficiary designation form itself required the trustee, as the beneficiary of the IRA, to draw all income from the IRA each year. This income would then flow out to the surviving spouse, as the income beneficiary of the QTIP Trust. This ruling seems to require that the terms of the QTIP Trust and the retirement plan (either directly or through the beneficiary designation) must include the Section 2056(b)(7) of the IRC requirements in order to qualify for the marital deduction.

   Rev. Rul. 2000-2, 2000-1 I.R.B. 305, approved another method for qualifying the IRA benefits for the QTIP election. In that ruling, the surviving spouse had the power under the terms of the trust to compel the trustee to withdraw from the IRA an amount equal to all the income earned on the IRA and to pay that amount to the surviving spouse. If the surviving spouse did not exercise the power, the trustee was required to only withdraw from the IRA the annual minimum required distribution. The ruling also held that the trust would qualify for QTIP treatment if the trustee was automatically required to withdraw from the IRA an amount equal to the income earned on the IRA assets, and pay that amount to the surviving spouse. (Rev. Rul. 2000-2 made Rev. Rul. 89-89 obsolete with regard to the earlier ruling's statement that only the trust described in the ruling would qualify for the marital deduction.)

   The IRS issued Rev. Ruling 2006-26, 2006-22 I.R.B. 939 to further define what is the Plan's income for marital deduction purposes.

3. Distributions. The income tax goal with IRAs and Qualified Plans is generally to leave the funds in the account or plan as long as possible, thereby deferring the income taxes on such funds. However, the participant must begin taking minimum required distributions upon reaching the required beginning date. Upon the death of the participant, the beneficiary must take distributions based on a complicated set of rules that, in very broad terms, depend upon whether the participant died before or after his required beginning date, who is the beneficiary and if the beneficiary is a "designated beneficiary" (a defined term under the IRC) on September 30 of the year following the year of the participant's death. See Treas. Reg. Section 1.401(a)(9)-4, A-4(a). Only individuals can be designated beneficiaries, excluding by definition, estates, charities and trusts. However, the individual beneficiaries of certain qualifying trusts may be treated as designated beneficiaries. Generally speaking, preferential treatment is given to the surviving spouse named as the sole beneficiary of a Plan, in terms of rolling over the Plan to the surviving spouse's IRA. Deferral may be sacrificed when the beneficiary of a Plan is a trust for the spouse, and not the spouse outright.

1. Distributions During Lifetime of the Participant.

1. General Rule - When the participant reaches his required beginning date, he must begin minimum required distributions. Under the 2002 final regulations, the minimum required distribution is computed in most cases by reference to the Uniform Lifetime Table found in A-2 of Reg. § 1.401(a)(1)-9. The Uniform Lifetime Table assumes the joint life expectancy of the participant and a beneficiary who is ten years younger than the participant. The distribution is no longer affected by the designated beneficiary named at the required beginning date, except as provided below.

2. Exception - One exception to the rule that the beneficiary named as of the required beginning date does not affect the participant's calculation of distribution amount is the case of a participant whose spouse is more than ten years younger than the participant, and such spouse (or a trust for such spouse) is named as sole beneficiary on the participant's required beginning date. In such case, the applicable distribution period is determined by the Uniform Lifetime Table or the actual joint life expectancy of the participant and the spouse, whichever is longer. Reg. § 1.409(a)(1)-9, A-3. Thus, if the participant's spouse is significantly younger than the participant, use of the actual life expectancy for the couple may minimize the minimum required distributions, and therefore defer the income tax payable upon such distributions. To take advantage of the joint life expectancy exception (for a younger spouse) set forth above, then the participant must comply with the additional trust documentation requirements. Namely, the participant must provide the plan administrator a copy of the trust agreement and agree to provide any amendments within a reasonable time. Reg. § 1.401(a)(9)-4, A-6. Note that the participant is relieved of this documentation requirement in most other instances.

2. Distributions Upon Death of the Participant.

1. Death Before Required Beginning Date – Under the Regulations (which trump the IRC) in the case of the death of the participant before the required beginning date:

1. if there is not a designated beneficiary, the 5 year rule applies;

2. if surviving spouse is the sole beneficiary, she may (a) take distributions when the participant would have been age 70½ or within 5 years depending on the Plan's provisions, or (b) rollover the plan or IRA to the surviving spouse's name and treat the same as the surviving spouse's IRA, using the surviving spouse's required beginning date; or

3. if the designated beneficiary is other than the surviving spouse, distribute the plan using beneficiary's age beginning on or before December 31 of the year following the year of the participant's death unless the Plan permits the beneficiary to elect the 5 year rule. See Treas. Reg. Section 1.401(a)(9)-3, A-3. The advisor must determine the deadline for making an election described in (2) and (3) under the Plan.

2. Death of Participant On or After Required Beginning Date – If the participant dies on or after his required beginning date, then:

1. if there is not a designated beneficiary, the plan is distributed over the remaining, non-recalculated life expectancy of the participant (see Treas. Reg. Section 1.401(a)(9)-5, A-5(a)(2));

2. if the surviving spouse is the sole designated beneficiary, she may (a) elect to rollover the plan or IRA into the surviving spouse's own IRA and begin distributions based on her required beginning date, or (b) take distributions from the plan over the surviving spouse's life expectancy, recalculated each year starting no later than December 31 of the year following the year the participant died [Reg. §§ 1.401(a)(9)-5, A-5(c)(2) and 1.401(a)(9)-3, A-3(b)(1)]; or

3. if the designated beneficiary is not solely the surviving spouse, then the plan is distributed over the non-recalculated life expectancy of the oldest (or sole non-surviving spouse) beneficiary, or over the remaining life expectancy of the participant (not recalculated), if that is longer (Treas. Reg. Section 1.401(a)(9)-5, A-5).

3. Trust as Beneficiary. If a trust is named the beneficiary of a plan, the individuals who are the beneficiaries may be treated as designated beneficiaries if certain requirements specified in Reg. § 1.401(a)(9)-4, A-5(a) are met:

1. Valid - trust is valid under state law;

2. Irrevocable - trust is irrevocable or if created by Will, by the terms, becomes irrevocable at the death of the testator;

3. Individuals - trust beneficiaries are individuals and are identifiable (watch out for power of appointment and contingent beneficiaries); and

4. Documented - documentation has been provided to the administrator of the plan (by October 31 the year following the year of death of the participant).

4. Benefits Payable to Trust for Spouse. There are two possibilities if the IRA is payable to a trust for the spouse instead of being paid to the spouse outright. If the trust is a conduit trust (that is, all IRA distributions flow out to the spouse with no possibility of accumulation), then the distributions may be made over the spouse's life expectancy, recalculated annually. If the trust is not a conduit trust, then distributions must be made over the oldest beneficiary's fixed life expectancy (presumably the surviving spouse), with the same issues as discussed above (regarding non-individual beneficiaries and powers of appointment) for death prior to the required beginning date.

5. Conduit Trust. The more common trust used to qualify for designated beneficiary treatment is a conduit trust. This trust requires all of the distributions from a plan to be distributed to the beneficiary at least annually. This trust might be useful if desiring management rather than deferral or preservation of the plan. If the surviving spouse is the current beneficiary of the conduit trust, she will be treated as the sole designated beneficiary.

6. Accumulation Trust. If the terms of a trust do not meet the distribution requirements of a conduit trust, but otherwise meet the Regulations' requirements for a designated beneficiary, then the trust beneficiaries may qualify as designated beneficiaries, with the plan distributed over the life of the oldest beneficiary. Reg. § 1.401(a)(9)-5.

4. Economics. The new regulations make it somewhat easier to have IRA benefits payable to a QTIP trust and maintain some deferral on distributions. Nonetheless, from a business standpoint, such an estate plan is often not satisfactory for several reasons.

   First, when the spouse is the beneficiary, he or she always has the option to roll-over the IRA, deferring distributions until he or she reaches the required beginning date. This option is not available when a trust is the beneficiary.

   Second, when the spouse is the beneficiary and rolls-over the IRA, not only are required distributions deferred until the spouse attains age 70½, at that time the minimum distributions will be based on the Uniform Lifetime Table for the spouse's lifetime, rather than the Single Life Table (which the later table will cause 100% to go out) and thereafter based on the children's life expectancy.

   Finally, when distributions are made to the QTIP trust, there are two possibilities as to the distributed funds. Either the funds are distributed out to the spouse (because the trust is a conduit trust, or because it is a mandatory income distribution) or the funds are accumulated and taxed at the higher trust income tax rates. Both of these possibilities may be contrary to the participant's goals.

5. What to do? Our firm's general practice is to advise the client to name the spouse as the primary beneficiary and the "Trustee named in the Will" as the contingent beneficiary. Under the Will there is a special provision that captures such distributions to the Trustee and provides for the distribution following the client's trust-oriented plan through a separate trust that meets the designated beneficiary rules.

   A Charitable lead trust with the remainder beneficiaries being the children from the first marriage is another way to minimize tax while separately providing for the respective families.

5. FIRST FAMILY v. SECOND FAMILY. Sometimes the blended family is the result of one spouse having two sets of children, the "first family" with a prior spouse, and the "second family" born from the marriage to the current spouse.

1. Concerns. In this situation, it is likely that the educational needs as well as the support needs of the older children have been satisfied. Many of these older children are self-sufficient. The younger children of current marriage must be supported and educated in the event that both parents are gone. In a typical Bypass trust / QTIP trust plan, this couple will face the same issues found above in Section III. D.

2. Solutions. It is reasonable to treat the older children as a distinct family unit, separate and apart from the "new second family." The parent of the older children may wish to take care of the older children by leaving some assets immediately to the older children upon his death. The remainder of the estate could pass pursuant to a typical Bypass trust / QTIP trust plan, and the children of the second family can be the remainder beneficiaries.

   Life insurance is a good vehicle to use to provide for the older children immediately upon the death of their parent. The children could own the life insurance or it could be owned by a life insurance trust for their benefit. This is estate tax advantageous in that the proceeds will not be subject to estate taxation upon the parent's death.

6. LIFE PLANNING. It is essential that the client review and update the life planning documents (described below) that he or she signed before the marriage. In most instances, the appointment of a former spouse is automatically cancelled upon the divorce from such spouse. If the law cancels the original agent, there may not be a successor or alternate to serve in for the principal. Finally, in a blended family, when a situation arises that requires the agent to act for the principal, sometimes it is the mere disclosure of who is in charge, who has the authority or was named as an agent, that can cause friction in the family (families) of the client.

   The following is a list a the type of life planning documents clients should consider and obtain, if appropriate.

1. Power of Attorney. A power of attorney is a document by which a person (the "principal") appoints another person or corporation to act as his agent. The power the principal gives the agent may be limited to a specific act or may be broad in nature, and may be limited to a specific time period or continue until terminated or revoked.

2. Medical Power of Attorney. This document names an agent to make health care decisions in the event a patient lacks the competency (as certified by the attending physician) to make such treatment decisions. The agent's decisions are to be based on this or her knowledge of the patient's wishes, and if the agent does not know the patient's wishes, then based on what will be in the patient's best interests. This power may be revoked. If there is not an agent appointed, medical treatment decisions will be made by the next of kin based on priority specified in the statute.

3. Directive to Physicians. This document instructs the attending physician not to take any heroic action to prolong life by artificial means in the event the patient is diagnosed with a terminal or irreversible condition. To be effective, the attending physician must certify the diagnosis. There is a statutory form.

4. Declaration of Guardian. This document names the person (or entity) the declarant desires to be his or her guardian of the person or estate if the need later arises. Unless the person named as guardian is disqualified from serving, the Court will appoint that person in preference to anyone else. By this document, a person may also name the person (or entity) he does not want to serve as guardian. A parent may designate a guardian for a child in the event of the parent's death or incapacity. There are statutory forms for each type of appointment.

5. Disposition of Remains. Written directions for the disposition of a person's remains may be made in a Will, pre-paid funeral contract, or a written instrument signed and acknowledged.

6. HIPAA Authorizations. Under the Health Insurance Portability and Accountability Act (HIPAA) information obtained and retained by health care providers and related industries are subject to the Act's Privacy Rule. 45 C.F.R. Parts 160-164 (2002). Accordingly, a patient's records cannot be shared except in accordance with the Rule. The Act recognizes agents under a durable power of attorney or an effective medical power of agent as personal representatives of the patient who may have access to the patient's private health information. Most people prefer not to have a copy of their durable power of attorney (designed for business matters) filed in their medical file. Accordingly, a patient should consider executing a separate power of attorney authorizing the persons named as agents under the patient's medical power of attorney access to such medical information.

7. Declaration of Mental Health Treatment. The Declaration for Mental Health Treatment allows a person to indicate their consent, refusal and preferences for mental health treatment, including psychoactive medications, seclusion, restraints, and convulsive treatment.