Second marriage: Know the financial implications

How does a second marriage impact my retirement and estate plan?

Physicians are among the increasing number of Americans impacted by divorce and/or remarriage each year. While there are many non-financial issues to consider when going through a divorce, financial implications must also be examined, especially in the event of a second marriage. Current income and estate tax laws provide many benefits for married couples. The key in any situation is to make certain decisions aren’t being made just to save taxes, as opposed to examining the implications of those changes for your children and possibly the children of your new spouse.

For the majority of physicians, retirement plans represent their single largest investment holding. Upon retirement, qualified plan proceeds are typically rolled over into an individual retirement account (IRA). Married individuals are allowed a unique tax savings strategy at the time of the IRA owner’s death. If the spouse is named as the beneficiary of the IRA or qualified retirement plan, the spouse is allowed to roll over the proceeds into their own IRA. Based on current tax law, only the spouse can roll over a retirement account and maintain the full tax benefits of the deferral.

Bear in mind that in the case of a second marriage, the new spouse, not the IRA owner’s children, inherits the full value of the IRA account. Additionally, once the new spouse completes the rollover as the named beneficiary, he/she has the right to name the beneficiaries of the new IRA. With the original IRA owner deceased, the new owner has no legal obligation to name his stepchildren or any other family member of the decedent as beneficiary. It is, therefore, very possible that the original IRA owner’s children will inherit nothing from this substantial asset.

Retirement plan issues are often brought to the fore during prenuptial agreement discussions. However, based on current tax law, the new spouse’s marital rights in qualified retirement plans cannot be waived in a prenuptial agreement. Those rights can be waived only by the new spouse after the marriage, so a prenuptial agreement is not applicable.

Equally important is the impact of a second marriage on the physician’s estate tax plan. Current estate tax law provides an unlimited marital deduction, which effectively allows any amount of assets to pass to a current spouse completely estate tax free. While this generous tax benefit is difficult to ignore, use of the deduction places control of the passed assets in the new spouse’s hands, potentially disinheriting other suitable beneficiaries such as the decedent’s children.

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One method commonly used to provide for the new spouse during his or her life, with the remainder going to other named beneficiaries, is a qualified terminable interest property (QTIP) trust. Via the unlimited marital deduction, the assets still pass completely estate tax free, but the new spouse has only limited access to the trust assets. Typically, just the income from the QTIP trust is available to the spouse, while access to the principal is limited to needs related to health, maintenance, and welfare.

While this technique accomplishes the goal of controlling who the ultimate beneficiary of the remainder estate will be while still providing income for the new spouse over her lifetime, there is another issue to consider. If the new spouse is much younger than the physician, how old will the children be once they ultimately inherit the estate upon the new spouse’s death?

Of course, there are many more financial issues to reconcile relative to a second marriage. Prior to making any changes in your beneficiary designations or your estate plan, be sure to consult your financial planner as well as your estate tax planning attorney.

How do you remove the value of a life insurance policy from the estate?

The vehicle used for this purpose is an irrevocable life insurance trust (ILIT). When properly structured, the ILIT can be both the owner as well as the beneficiary of a life insurance policy, without being estate taxable at any time in the future. The trust escapes estate taxation because the insured has no ownership of the policy. Due to this inherent lack of control, term insurance is often the product of choice when funding the trust. Because term insurance has no cash value, it is purchased for the death benefit only as opposed to any investment advantages that other types of policies offer.

If an existing policy is transferred to an ILIT, the original policy owner must outlive the transfer by at least 3 years in order to avoid gifting-in-contemplation-of-death rules, which would nullify the tax advantages of the trust (IRC Sec. 2035). If, on the other hand, the insurance policy is owned initially by the irrevocable trust, the 3-year rule does not apply.UT

Like this article? Check out these other recent installments of "Money Matters":

Real estate: Know your investment options

Save estate tax costs with exemption portability

Take these steps to avoid 'kiddie tax' exposure

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