A QTIP is a special trust that can make the next marriage easier for blended families

Successful estate planning can provide for the financial needs of your loved ones after you are gone.

With proper planning, your estate plan should also grow as your family and finances grow.

Consider the following relationship example.

Matthew and Elaine are married with three minor children. Unfortunately, like about half the population, their marriage does not work out, and they separate. Matthew moves in with his new girlfriend, Caroline, who is divorced with two minor children from her previous marriage.

Matthew and Elaine begin divorce proceedings, and Matthew plans on marrying Caroline as soon as his divorce with Elaine is finalized by the court.

Matthew's ongoing relationship with his children and soon-to-be ex-wife will be challenging. With alimony, custody, shared parenting, schools, scheduling, child-support payments and more, this is one of the most challenging and stressful relationship times in anyone's life.

And Matthew's financial and estate planning just became a lot more complicated. The court will determine the alimony and child-support payments in the divorce decree. These will be court-mandated payments that become a part of Matthew's monthly financial obligations. And they can also include items like school payments, insurance for his three children, summer camp, sports expenses, music lessons and more.

But beyond that, Matthew wants to provide for his children after he is gone and for Caroline, his soon-to-be new wife. And depending upon feelings and circumstances, he may take the needs of Caroline's children into account with his estate planning. And to make things even more complicated, if he and Caroline have children together, their needs will also be included in his estate planning.

In first marriages, estate planning is often fairly straightforward. Spouses typically have estate plans that leave all their assets to the surviving spouse. And even when they have children, they usually do not change their estate plans. The spouses believe that the surviving spouse will take care of their children and eventually pass all the family assets to them.

However, once you get divorced, these plans no longer work.

Whatever wills or trusts Matthew and Elaine have will most likely no longer reflect their wishes after they are divorced. For example, with a new wife, it is doubtful that Matthew will want to leave his entire estate to his ex-wife.

But if Matthew changes his estate plan and leaves his entire estate to his new wife, Caroline, what happens to his children? He would be relying on his new wife to take care of his children from his first marriage. He may want his entire estate passed to his children after Caroline passes away.

But what about her children? Or, what if she remarries? Or what if she decides to spend the entire estate?

Matthew wants to make sure that his children are financially supported. And he wants to make sure that Caroline is also financially supported during her life. But he wants to ensure that his estate is passed down to his children after Caroline passes away?

As he plans to start his new blended family life, his two main areas of concern are financial obligations after the divorce and estate planning for the blended family. He wants to ensure his estate planning addresses Caroline's financial needs and that his estate passes to his children after her death.

Matthew's financial obligations to his first family are usually determined during the divorce proceedings and detailed in the divorce decree.

Every state has different laws and terms for divorce proceedings. The court's decree includes the details in an agreement often called a marital settlement agreement (MSA).

Suppose the divorcing couple works together during the proceedings. In that case, the MSA can be flexible on specific issues like choosing schools, vacations and other items. And many states allow the couple to decide if alimony and child support will be paid through the court system or between the parties.

But if the couples are not cooperative, the judge or magistrate will have more exacting court-ordered actions put into the agreement.

The MSA details the financial obligation and the obligations regarding the children. Some of the items included are:

• Spousal support (sometimes called alimony)
• Child support (how much and is it through the court system; state laws vary)
• Children's health insurance (what coverage and who pays for it)
• Schools (where do the kids go and who pays for it)
• College (who pays for it)
• Shared parenting plans (sometimes called custody and visitation)
• Vacation schedules
• Marital home (is it kept or sold, who owns it and who lives in it?)
• Disposition of spousal personal liabilities
• Disposition of retirement accounts

In our example, Matthew will have the financial obligations to his first family spelled out in the divorce decree — and he will take on the obligations of his new wife and family.

So, Matthew and Caroline will need to have a budget that considers all of this. And this can be further complicated depending on Caroline's divorce settlement, if any, with her former spouse. For example, will Matthew be responsible for health insurance for both families, or will Caroline's ex-spouse still be accountable for Caroline's children? How much of Caroline's divorce settlement with her first spouse terminates upon her marriage to Matthew? Every state is different, and these critical details can be confusing.

An experienced financial professional and estate attorney can be invaluable in helping design a budget that works and is also compliant with all legal obligations of the divorce decree.

Review documents

The first and most crucial step is to review all current documents. This includes the divorce decree to ensure all legal obligations are met.

But equally important is to review all the estate planning documents executed by Matthew and his first wife. The two most common documents are wills and trusts.

Deciding what you want to put in your will takes thoughtful consideration, and usually entails working with an experienced estate planning attorney. Fortunately, revoking the old will is a simple legal process that is typically accomplished in the drafting of a new will.

Perhaps Matthew and his first wife may have executed one or more trusts, including a marital trust, family trust and revocable trust.

The goal would be to make sure that all the assets are properly moved and transferred according to the wishes and agreement between Matthew and his first wife.

But revoking a trust is different and more complicated than revoking a will. The will owns no property because it becomes effective upon the testator's death. But property is transferred into the trust during the grantor's lifetime, and there are specific legal procedures to be followed when revoking a trust and transferring property from it. Also, there may be tax consequences, depending on how the property is transferred.

Plan and prepare new documents

After careful planning with an experienced estate planning attorney, Matthew should have new documents drafted to ensure his blended family is provided for according to his wishes.

To avoid future confusion, Matthew and Caroline might draft and sign a prenuptial agreement. This is a written contract between the two intended spouses before marriage and details how they will divide things in the future should they get divorced.

Sometimes called a premarital agreement, the prenuptial typically lists each person's property and debts and then states what property and rights they will each own after the marriage. State laws vary widely on what terms and conditions are and are not enforceable in a prenuptial agreement. An experienced attorney should help with this document.

A well-written prenuptial can help with the following issues:

• Passing separate property to children from prior marriages.
• Clarifying the spouses' financial rights.
• Providing protection from debts of the other spouse.

After deciding on his estate plan, Matthew should execute a new will, as should Elaine and Caroline. Their circumstances have changed, and their current wills should reflect their new wishes.

However, since most estate plans include trusts, it is vital to coordinate the new will with the new trust documents. For example, many people trying to avoid probate use the combination of trusts with a pour-over will. The coordination between the will and the trust is crucial.

Trusts are powerful estate planning tools. They help avoid probate and give you the ability to ensure your assets and income are distributed after your death according to your wishes.

There are marital trusts, family trusts, revocable trusts, irrevocable trusts and more.

But one powerful estate planning tool that helps in with estate planning for blended families is the QTIP trust, a qualified terminable interest property trust.

For Matthew, a QTIP trust can ensure his assets are passed down to his three children while still providing for his new spouse, Caroline.

A QTIP trust is like other trusts but has special terms that can help Matthew provide for Caroline and protect the inheritance to his three children. Matthew would appoint a trustee who oversees the trust administration and manages the trust assets.

However, the assets that Matthew transfers into the QTIP trust are not gifted to Caroline when he dies. Matthew decides the income he wishes Caroline to receive during her lifetime, and the trust will pay her that amount according to the terms of the trust.

But Caroline cannot withdraw principal from the trust, nor can she decide the ultimate disposition of the trust assets. Customarily in a QTIP trust, the assets are transferred to the beneficiaries, in this case, Matthew's three children, after Caroline dies.

And if there is real estate involved, Matthew can direct the trust to give Caroline a life estate in the property. She can live and enjoy the property for the rest of her life. And the ownership of the property will pass to the beneficiaries, Matthew's children.

Whether the QTIP trust is created after death (testamentary) or during Matthew's life (inter vivos), the QTIP trusts must meet specific requirements, including:

• The QTIP trust must grant Caroline a “qualifying income interest for life.” Either all the trust's net income must be paid at least annually to the beneficiary spouse, or the beneficiary spouse must have the right to annually withdraw all the trust's net income. Caroline's right to income cannot be subject to any contingencies, like terminating should she remarry.
• Caroline must have the right to demand that the trustee convert non-income-producing assets into income-producing assets.
• The QTIP trust must be irrevocable.
• If Matthew chooses an inter vivos QTIP trust, Caroline must be a U.S. citizen.

It is allowed, though not required, to give Caroline the right to distributions from the trust principal (either discretionary or according to specific standards). However, no one other than Caroline can be a beneficiary of the QTIP trust during the beneficiary spouse's lifetime.

QTIP trusts serve two primary purposes:

1. They can allow the maximization of estate tax benefits by using the unlimited marital deduction.
2. They can allow a grantor spouse to put restrictions on their property rather than leave the property outright to their current spouse.

Restrictions are often helpful in a second marriage when there are children from the first marriage. And restrictions are often used when there are concerns about a spouse remarrying and giving away all the money and assets to their new spouse. Besides Matthew and Caroline, consider two more examples.

Example 1

Sue and Ken are in their mid-30s, married for 15 years, and have two minor children. Ken has a successful ongoing business but is in poor health. Ken realizes that Sue will outlive him and will most likely remarry. Ken wants to create financial security for Sue but is concerned about his children should Sue remarry.

To resolve this concern, they establish a QTIP trust. If Ken dies first, Sue will receive the income from his business and the other QTIP trust assets and property for her lifetime.

But Sue cannot sell the trust's property or give trust assets to a new spouse. Ken has the peace of mind of knowing that his business and the other trust accounts and property will eventually pass to his children after Sue's death.

Example 2

Robert is a successful businessman in his late 60s with four adult children from his first marriage. Robert recently married Joan, who was never married and had no children. Robert wants to ensure that Joan is financially supported during his life and after his death.

But Robert wants to ensure that his children receive most of his assets and property. Robert transfers only a portion of his assets into a QTIP trust for Joan's benefit. And then, Robert places the remaining majority of his assets into a nonmarital trust with his children as beneficiaries.

The income generated by the QTIP trust will provide for Joan during her life. After Joan's death, Robert's children will receive the remaining property of the QTIP trust. But separately, when Robert dies, his children will immediately receive the assets from the nonmarital trust.

In this scenario, Robert's children receive the bulk of his assets upon his death. Joan gets income for life. And Robert's children receive additional assets from the QTIP trust upon Joan's death.

Blended families are more and more commonplace.

But these expanded loving relationships come with financial complexities. First, you need to budget and plan for increased financial obligations. And what seemed like simple estate planning may now appear confusing and perplexing.

With a blended family, your estate planning goals are to financially provide for your spouse's needs after you are gone, and ensure your assets are eventually distributed to your children, according to your wishes.

Fortunately, there are powerful estate planning tools and strategies, like QTIP and other trusts, to help you ensure your wishes. But planning the best strategies for you and drafting the best documents requires expertise in legal, financial and tax planning.