The term “family” has a different, more expansive meaning today than it did in decades past. In the 1950s, one of the most popular television shows invited viewers to join the “Adventures of Ozzie and Harriet,” which centered around the Nelsons — Ozzie, Harriet and their two sons.
They were a traditional family: Harriet stayed home and never seemed to leave the kitchen. Fast forward to today, and we are entertained by the lives of the new “Modern Family.” This popular show’s main character, Jay Pritchett, is divorced and remarried to his second wife. They have a stepson, an infant son and two adult children.
The two fictional television shows illustrate how times — and needs —have changed, highlighting new family dynamics that could complicate the financial planning process. Understanding common family situations and raising the right questions with clients and prospects is critical to helping today’s families know how to use life insurance to manage complex issues and protect themselves.
One thing that hasn’t changed: The foundation of life insurance is to provide protection upon a client’s death. The death benefit would traditionally help replace the income of a deceased spouse, but truly serving family needs may not be so straightforward.
Consider our fictional example, John and Susan, who are beginning to build a financial plan. John is an executive at a large multinational company and the family’s major bread winner. Life insurance can help replace his income when he dies and enable Susan to maintain her current lifestyle.
However, it’s also important to address Susan’s role. Does she work outside the home? If so, are there child care needs? These questions may lead to a life conversation not only for John, but also for Susan.
Helping modern families
John and Susan may have had children together. They may also have children from prior marriages and are now raising a blended family. It’s important to understand John’s and Susan’s desire to take care of all of the children by asking a few questions:
Are the couple’s wills up-to-date?
Do they have trusts that specify the distribution of property upon their deaths?
Is there a life insurance need to ensure that each spouse is taken care of if there is substantial property being left to the children?
Without a comprehensive estate plan, a surviving spouse could become the sole beneficiary of all assets and custodial parent of all children involved in the marriage, even stepchildren with whom he or she may not get along. One of the most important aspects of estate planning is choosing the right executor, or the person to whom an individual grants to carry out his or her wishes. Especially in so-called non-traditional families, it is crucial that the executor chosen is one who will be fair to all beneficiaries and has no ulterior motives.
Planning for special needs
Let’s complicate the situation further by assuming one of John and Susan’s children, Molly, has special needs and requires assistance in several activities of daily living. In the future, Molly may be able to live outside the home, but may not be able to support herself. To secure Molly’s future, it’s most important to review financial resources allocated for her care to ensure she will not be disqualified from government assistance. It’s equally important to consult with an attorney with expertise in special needs planning to ensure Molly is taken care of after John and Susan die.
The family may need to establish a special needs trust for Molly; life insurance can be an effective funding vehicle for that trust. Life insurance can provide the family with the comfort of knowing that even if Molly faces financial setbacks, she will have a source of assets for the trust.
Life insurance directed to a special needs trust can also provide flexibility by providing adequately for the child with special needs while allowing the parents to direct other assets, such as retirement assets or business assets, to other children. Life insurance is also a useful tool when parents want to leave a larger share for the special needs child and smaller shares for any siblings.
Estate taxes need attention
Let’s add one additional wrinkle: Susan is not a U.S. citizen. This has an estate planning impact, because she can’t take advantage of the unlimited marital deduction for estate taxes because all assets left to a surviving spouse are free from federal estate tax — but only as long as the surviving spouse is a U.S. citizen, even though they may be permanent U.S. residents.
In short, the cap on the estate tax marital deduction for noncitizens prevents them from inheriting large amounts of money and then leaving the country to without paying estate tax on at least a portion of the estate. Federal law does exempt all beneficiaries, no matter their citizenship, from estate tax for assets up to $5.45 million (as of 2016). And in this example, if Susan dies first, assets left to John, who is a U.S. citizen, qualify for the unlimited marital deduction.
A special trust called a “qualified domestic trust,” or QDOT, provides a way for noncitizen spouses to inherit assets free of estate tax. Using a QDOT, a U.S. citizen spouse leaves property to the trust, instead of directly to noncitizen spouse, making her the sole beneficiary of the trust during her lifetime. So, through a QDOT, Susan would receive tax-free income generated by the trust property. However, if Susan were to collect the trust’s principal assets, she would need to pay taxes on that property.
One exception to that guideline: when distributions are made because a spouse has an urgent, immediate need and no other resources. The legal rules around QDOTs are complicated and clients must consult with an experienced estate planning attorney.
Another option to minimize estate taxes and provide greater flexibility and liquidity for Susan is through an irrevocable life insurance trust (ILIT). In this case, John could establish an ILIT and fund it with gifts.
The trust could also contain spousal access provisions (a spousal lifetime access trust), which could also provide supplemental income for Susan during her lifetime, and keep trust assets outside of John’s taxable estate. Life insurance can be an effective funding vehicle inside the ILIT. The cash value would grow tax-deferred and the death benefit is tax-free.
If John and Susan consider retiring outside the U.S., they will also need to think about other tax issues, including U.S. income taxes, foreign taxes and business taxes. In addition, they will need to review their healthcare planning. For example, they’ll need to consider whether their long-term care insurance, or other product with a chronic illness benefit, covers them while living abroad.
Finally, business planning could be another important component in a comprehensive financial planning discussion. Assume John left his job and opened his own printing company, which has become quite successful. He has five employees, one of whom is his son, Craig, from his first marriage. Craig is very active in the day-to-day management of the business and has expressed interest in inheriting the business some day.
Among important questions to consider: whether John needs key person insurance to create a “Golden Handcuff” for Craig or even whether he needs key person insurance for himself?
Planning for today’s “modern family” may present unique issues. However, with careful review and analysis, these issues can be addressed and clients’ current and future needs can be met.
Life insurance can be an important cornerstone in many situations. In addition to providing a death benefit for beneficiaries and future generations, today’s products, features and benefits, can also address other needs, such as chronic illness. That’s a comprehensive solution to a comprehensive problem.
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