A: A lot of people these days face questions just like yours. That's not surprising, considering that nearly two in five people age 50 or older belong to blended families, according to a Merrill Lynch study, Family & Retirement: The Elephant in the Room.
Each family situation is different. While I can't say what the right strategy might be for you personally, I do know that many in your situation name their spouses as primary beneficiaries of their estate and their children as secondary beneficiaries. Unfortunately, that can create problems—as your children might have to wait years after your death, or until their stepmother dies, to receive their inheritance.
Some people find trusts a fair and effective alternative. Though they may have a reputation for being complicated, trusts can actually make a lot of sense for people who are looking for ways to provide for their families from two marriages. In your case, you might consider something called an irrevocable life insurance trust, or ILIT. This is a trust that typically holds life insurance, but it may hold other assets as well.
Here's how it works: If you create an ILIT with a life insurance policy that names your children as beneficiaries, they will receive the proceeds of the policy immediately upon your death. And because the policy is in a trust, they won't owe estate taxes. (Note that if the life insurance policy was originally taken out in your name, the IRS requires that three years must pass after it is transferred to the ILIT before it will be considered exempt from estate taxes. You also need to be careful to follow proper procedures for premium payments.) Premiums on the insurance could be paid through annual gifts—which may be free of federal gift tax. This will likely free you up to provide for your current wife with the other assets in your estate.
I like to point out another advantage to ILITs—the permanent life insurance policy within them can generate competitive returns. People often look at life insurance purely as something they pay into, but it might be more accurate to think of it as a way of investing that can help you reach your financial goals.
3 Questions to Ask Your Advisor
- Can you help arrange a meeting with me, my wife and my children to to discuss a financial plan for my estate?
- What is involved in setting up an irrevocable life insurance trust?
- How can life insurance help me meet my financial goals?
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