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Paul Hamilton | Being fair with inheritance plans

Hey Paul: My first marriage to Tom lasted thirty years until his death in 2000. Tom and I had three children. I have been remarried to Jack for ten years and he has two children from his first marriage. I have worked but have only earned about half of what both Tom and Jack earned in their jobs. Jack and I are now in our 70’s (my children are each married and in their 40’s) and we want to make inheritance plans.  How can we best provide for the surviving spouse and be fair to the children?

You are off to a good start on estate planning. The fact that you are having conversations about the difficult topics surrounding estate planning and are working towards “a plan” is half the battle. Of course the other half of the battle is actually coming up with the plan.

Each family’s situation is a bit (or a lot) different in terms of wealth accumulation, earnings difference, spousal age gap, and how well the second spouse gets along with the children. To complicate matters further, the events after the first-spouse’s death vary – Do they remarry?  What are the investment returns? Just to name a couple of the uncertainties. 

The first thing I would recommend is to determine the base level of income that you would need as the surviving spouse. This number should be minimalist in covering food, utilities, gas, home and auto maintenance, various insurance premiums and medical expenses, and rent or mortgage if you do not own your home. Add 10 to 20 percent to this number to capture miscellaneous items, rising costs, or unexpected expenses. For most people, I would expect this monthly budget to be around $2000 to $2500 if you own your home.

On that note, I would encourage you to pay off any mortgage as soon as reasonably possible. You likely are not receiving much, if any, tax benefits from mortgage interest expense. Likewise other debt including low-interest auto loans or high-interest credit cards should be paid down ahead of schedule if at all possible.

Back to your story – let’s suppose you can live fairly comfortably on $2,500 a month or $30,000 a year.  Further let’s suppose that Jack’s Social Security benefit is $1,800 and your spousal benefit is $900.  When the first spouse dies the surviving spouse will receive $1,800 in benefits – Jack as his own benefit or you as a widow benefit. There is also the possibility that you can receive a higher widow if you remarried after turning age 60 and Tom’s benefit was higher than Jack’s benefit.

I say all this not to suggest that Social Security will cover all your future spending needs. Social Security benefits average around $1,300 and could be much less if income was very modest and the worker did not work the full 35 years that the SSA counts income.  However, for many couples and then the surviving spouse, Social Security provides an inflation-protected income base.

In your case my guesstimate is that it covers about three-quarters of your spending needs. This does not include two important spending dimensions. First, you may not want to plan just to have your basic needs met but rather plan to live “quite comfortably.” In this case, scale the budget as you see fit. Secondly, the base budget did not include potential high expenses from medical or long-term care.  

My suggestion for both you and Jack is to form a living trust that will be overseen by an independent trustee (usually a bank) after either of your deaths. The trustee would distribute income sufficient to meet your (or Jack’s) living expenses in tandem with Social Security and any other pension or annuity assets. A provision could also be made that the surviving spouse could access further assets to meet medical or LTC expenses.

The trust then serves the purpose of “taking care” of the surviving spouse while also potentially keeping some assets to bequest to the children after the second spouse’s death.  Depending on the amount of wealth, spend-down rate, and how long you live there, may be nothing left for any of the kids.

You may consider making an initial bequest to the children of the first spouse. It doesn’t have to be large, but could make a financial difference in their life decades earlier, rather than waiting for the demise of their step-mother. Even sentimental gifts may make a difference in how the family views the fairness of the estate distribution.

Trusts aren’t the answer for everyone. For their services, the trustee may command hefty fees along with annual taxation of the trust. If you have modest wealth to leave to your spouse and children, then your children may just have to live with the reality that what you gave during your lifetime to them is all they can expect to see.  The good news is that I have yet to meet anyone who claimed to have a great mom and dad and mentioned anything about a large inheritance.

Dr. Paul Hamilton, CFP is an Economic Professor at Asbury University and fee-based financial planner offering advice for a monthly retainer fee of $100.  Contact him at Paul.Hamilton@Asbury.edu with any financial questions you may have.