Insuring Legacies

     Did you know that you may unintentionally disinherit your children from your Qualified Retirement Plans (QRPs), especially if yours is a blended family?
     To illustrate this point, assume the following facts:

1. Husband and Wife have adult children from their respective prior marriages and a minor child together.
2. Wife has a $2 million QRP.
3. Wife selects Husband as the Designated Beneficiary (DB) of her QRP.
4. Wife establishes a Credit Shelter Trust (CST) with Husband and then children as beneficiaries.
5. Wife also names the CST as the Contingent Beneficiary of her QRP.
6. When Wife dies, Husband inherits the QRP as an income-tax-deferred rollover.

     Dilemma #1: What will Wife's own children inherit from her upon Husband's subsequent death if:
     (a) Husband does not disclaim the QRP to Wife's CST; or
     (b) Husband fails to specifically identify Wife's children as among the Primary DBs after rolling over Wife's QRP to his own name?
     Answer: Nothing.
     Dilemma #2: Can Wife identify her CST as the Primary DB of her QRP instead of Husband without his knowledge?
     Answer: Generally no. With very limited exceptions, under federal law a surviving spouse has special rights to a (non-IRA version) QRP of the deceased spouse.
     Is there any alternative that would allow Husband to rollover the QRP, while ensuring that Wife's children are not totally disinherited?
     Answer: Yes, by insuring their legacies through a funded Irrevocable Life Insurance Trust (ILIT).

The ILIT

     Here is how an ILIT funded with a proper amount of life insurance would benefit the blended family in our case study.
     First, Wife identifies Husband as the Primary Designated Beneficiary of her QRP, with her CST as the Contingent. Wife's CST identifies Husband as the primary beneficiary, with all their children as the remainder beneficiaries. Upon Wife's death, Husband can either: (a) elect the QRP rollover for the income tax savings; or (b) elect to disclaim the QRP, sending it to Wife's CST.
     If Husband elects (a), then he must arrange his Primary Designated Beneficiaries to include Wife's children or they will be disinherited. If he elects (b), then neither he nor any of the couple's children will be disinherited.
     Second, Wife creates an Irrevocable Life Insurance Trust (ILIT) that in turn applies for and owns a $2 million life insurance policy on her life. The ILIT is named as beneficiary under the policy, with Wife's children as the beneficiaries of the ILIT. Because neither Wife nor Husband is the applicant, owner or beneficiary of the $2 million policy, the proceeds are not included in their estate value for federal estate tax purposes.
     Third, upon Wife's death, she is assured that her children will inherit $2 million from her through the ILIT … even if Husband elects the QRP rollover and fails to include her children among his Primary DBs.