Changing Nature of Estate Planning:
Part III - Divorce & Other Conflicts

“Marriage is often due to lack of judgment, divorce to lack of
patience and remarriage to lack of memory.”

The first in this series of articles discussed some of the underlying reasons and philosophies for the changing nature of estate planning. The second article discussed how estate plans can be structured to influence heirs. This article will discuss how estate planning is increasingly focused on ways to minimize the effect of conflict. The topics and planning ideas in this article are not intended to cover every issue or planning opportunity. Instead, they are designed to give planners the flavor of how these issues are changing the nature of estate planning.

Conflict is a natural part of human existence. Unfortunately, the trauma of death, disability and divorce tend to significantly magnify conflicts which already exist. If the first goal of estate planning is to “Protect and Preserve the Family” then exploring methods which reduce the results of conflict should be a part of every estate plan.

Marriage, Divorce & Blended Families

Perhaps Will Rogers had it correct when he said: “I guess about the only way to stop divorce is to stop marriage.” According to Time magazine, (1) 49% of all US marriages end in divorce. If such a high proportion of marriages end in disaster, we as planners should include the probability of dissolved marriages in planning for clients.

Divorce is largely an ignored issue in most estate planning. (2) However, the high divorce rate means that planners will increasingly have to deal with the complexities of blended and dysfunctional families and competing spousal views of how children and stepchildren should be treated. Virtually every estate plan should address the potential of both the client’s and the client’s heirs potential divorce.

Among the considerations planners should discuss with clients are:

• Prenuptial agreements have become an important part of estate and asset protection planning. (3) While not particularly romantic, the high incidence of divorce should cause any client with significant wealth to consider signing a pre-nuptial agreement. The agreement must be carefully drafted. (4) For example, in a series of decisions (5), the federal courts have ruled that a spouse’s right to an ERISA retirement plan (6) cannot be waived prior to marriage. Thus, if the parties intend for such a waiver, it should be signed after the marriage is official.
• Even if a pre-nuptial agreement is signed, clients should consider revising their estate planning documents before their marriage. In many states, marriage automatically revokes all prior wills, leaving both spouses without documents disposing of their assets. For example, assume a couple marries and neither spouse has any children. The wealthier spouse dies in a car accident and the other spouse dies the next day. Most state intestacy laws would pass 100% of the wealthier spouse’s assets to the surviving spouse. The only intestate heir of the surviving spouse is the spouse’s family who have a strong financial incentive (i.e., 100% of the assets) to argue that any pre-nuptial agreement did not govern intestate rights which could not accrue until after the marriage. (7)
• When a divorce is anticipated, the client should consider executing new estate planning documents in contemplation of the divorce. Does your client you really want a soon-to-be ex-husband to have control of her property or medical decisions if she become incapacitated?
• Although the disagreements may impede the possibility, clients should consider implementing transfer tax saving approaches before a divorce is finalized. The planning could include using gift splitting before the divorce, (8) using the unified credit of the less wealthy spouse to support tax-free transfers to the heirs of the wealthier soon-to-be exspouse and making sure any property transfers to an ex-spouse qualify for tax-free treatment under the transfer tax rules. (9)
• Trusts should be drafted in contemplation of the possibility that one or more of the beneficiaries will get divorced. For example, assume a husband creates an irrevocable life insurance trust and names his wife as a beneficiary and co-trustee. The trust instrument might provide that all benefits, rights and powers of the wife, including serving as co-trustee, immediately terminate upon either legal separation or divorce. Few clients want an ex-spouse to financially benefit from their death or be able to control the inheritance of the assets.
• Clients should consider the possibility that one or more heirs will become divorced. Clients should consider inheritance vehicles which restrict the ability of an heir's exspouse to obtain part of the familyÕs assets. For example, the last thing most family businesses need is an ex-spouse attempting to gain some control over the family business. Placing family assets in spendthrift trusts (10) and drafting buy-sell agreements (11) in contemplation of this possibility can reduce the ability of a divorcing spouse to benefit from family assets.
• Planning should contemplate that a surviving spouse may remarry. For example, assume a widower remarries and then dies. There could be claims against the deceased husband’s estate by the surviving widow. State statues may permit the widow to claim support from the deceased’s estate, or assets may have been placed in joint names, with the widow taking survivorship rights. If assets of the first wife are held in unified credit and martial trusts, the surviving second wife can be denied property rights in the trust assets. Such trusts not only protect against the claims of a surviving widow, they also protect against claims of a divorcing spouse from a subsequent marriage.
• Any trust which limits the rights of an heir’s former spouse should also contemplate child custody issues. For example, if a descendant is divorced and the non-descendant parent has custody of minor descendants, the trust should provide for how the ex-spouse is treated and what degree of control he or she retains over the children’s trust benefits. If the trust requires that the trustees provide funds for the minor, it may open the trustees up to demands from the ex-spouse for greater benefits than the family intended. It may be better to give the trustees broad discretion in the amount to be paid for a minor heir and allow them make payments directly to third parties for the benefit of the minor, rather than being required to make the payments through the child’s custodial parent.
• Improper retirement plan beneficiary designation changes can create huge problems in divorce cases. (12) For example, in Merchant v. Corder, (13) the Fourth Circuit Court of Appeals ruled that a change in beneficiary designation to a retirement plan prior to the issuance of a final judgment of divorce was invalid. Because the ex-spouse had not agreed to the relinquishment of her rights to the plan at the time of the change and there was not a qualified domestic relations order, the retirement plan of the deceased former husband passed to the ex-spouse.

As a result of a high divorce rate, the United States has a large number of blended families. According to one study, more than 50% of all American families are blended families. (14) Clients are increasingly struggling with how to fairly treat each member of the blended family. For example, should the children of the less wealthy spouse participate in the inheritance of the assets of the wealthier spouse? Planning documents must contemplate the possibility that a surviving second spouse will disinherit the children from the deceased spouse’s prior marriage. Even if the stepchildren are currently close to the stepparent, the relationship may dissolve later, or blood relatives may pressure the surviving spouse to disinherit the stepchildren.

Reducing Conflict

From both their personal experiences and from frequent articles in the media, (15) clients have seen horrible conflicts erupt among family members. Many clients have an abiding desire to establish structures which minimize the points of conflict and provide a mechanism to resolve family conflicts. One of our most important legacies is disposing of assets in a manner designed to minimize family conflict - LEAVING A LEGACY OF RELATIONSHIPS RATHER THAN A LEGACY OF CONFLICT. This perspective should be at the core of every estate plan, from the manner that assets are passed, to the selection of fiduciaries. Although conflict can erupt from multiple sources, there seem to be some areas that have a higher propensity for creating the conflict.

Personal Property Dispositions. The attention paid to personal property after its owner’s death is often disproportionate to both its focus in the pre-death estate plan and its appraised value. One of the more interesting dynamics of estate planning is that in many cases, the greatest intra-family conflict is not over a large inheritance or the placement of assets in spendthrift trust, but as an unexpected result of personal property dispositions. (16)

Among the ways that clients can minimize conflicts are:

• To the extent the client wants a particular asset to go to a particular person, the client is best advised to provide a legally enforceable document that passes that particular asset (defined with specificity) to a particular heir. This is especially important when assets are being transferred to more remote heirs (e.g., family friends or remote cousins).
• Clients should be strongly encouraged to talk to their children about which assets they want to receive upon the parents’ death. These desires should be documented. This brings to the fore any ownership conflicts that may exist prior to the parents’ death. Because the parents resolve the conflict, any long term damage in the children’s relationships can be minimized.
• To the extent the particular assets are to be passed to the children, we typically recommend that either a digital or videotape be made of the object and a notation be made of which family member receives that asset. Through the video representation of the asset, there can be little question as to which asset is being passed. Moreover, if a video camera is used, it is an excellent way of providing the legacy of any heirloom assets so the heirs understand the family history of the particular asset.
• Clients should document the ownership of their assets. For example, if a daughter lent her mother a china cabinet, then it needs to be documented somewhere that the china cabinet belongs to the daughter and not the mother. In the absence of such written information, it would generally be presumed that it belonged to the person in whose home it was found.
• If a married couple has children from prior marriages, they should create a notebook with pictures of their important assets (as defined by the family), noting the heir of the asset. Each spouse should sign a document irrevocably relinquishing the right to the other’s assets, except where a written statement is signed by both.
• The choice of an executor can be very important because the client wants to make sure that these personal property dispositions occur in exactly the manner that the client desired. Therefore, the choice of a child or second spouse as executor may sometime create a conflict with the other children and may not be the best choice.
• Some clients want to give a life estate in personal property to a spouse and then pass the property to their family. Unfortunately, this is a terribly cumbersome approach. What happens when the object breaks, is stolen or lost? Particularly with an heirloom and emotionally significant assets, it is generally best to pass them at death to the end recipient.
• As soon as the client becomes disabled, or immediately upon death, we typically advise the executor (perhaps even before an appointment) to immediately change the locks on any residence or other location holding personal property so that the executor is in control of the property. There may be a number of people who have access to the property who may think they are entitled to some particular asset.

Incapacity - Many families have been scared by guardianship fights in which a frail parent has attempted to fight off questions of competence. Questions of competence and its often cited twin, undue influence, have lead to many will contests. Mental capacity is an elusive concept at best and the degree of capacity required to execute a document may vary based upon the document. (17) Capacity may even vary by the time of the day.

Particularly in the context of a will contest, the burden of proving that the signer of the document was incapacitated rests with the challenger. It will often be a tough burden to prove. When an elderly client makes significant decisions (e.g., signing a new will; making significant gifts, placing a family member in charge of a family business) which are adverse to another party, particularly an heir, special steps should be taken to minimize future questions of capacity. The steps include:

• Have the client’s doctor present at the meeting and have the doctor submit an affidavit that the doctor examined the client prior to and after the signing and believed the client was competent.
• During the execution session, ask the client what children and grandchildren he or she has and where they live. Ask the client about what assets are owned and their expected value. Ask the client questions about the nature and consequences of the document being executed.
• To reduce claims of undue influence, do not have family members or others who might benefit from the changed documents attend the client meeting.
• If there is questionable capacity or significant changes by a person facing imminent death, go thorough the above processes and have both the witnesses and notary describe in an affidavit in their own words what they observed.
• In important situations, review having the execution of documents videotaped. However, this can be a problem if the tape indicates the client had some confusion about the document or its consequences, or the process is inadequate to indicate the client’s true understanding of the documents being executed.

To avoid conflicts over who will serve as guardian for property and medical purposes and how the exercise of authority will occur, every client should consider drafting medical powers of attorney and general powers of attorney. This issue was discussed in the first article of this series.

Choice of Fiduciaries - The choice of fiduciaries is one of the most important decisions a client can make. The choice of the right fiduciary can either avoid or create conflict. In selecting the persons who will act for the estate, the client should focus not only on the fiduciaries competence, but also on the potential for conflict. It is the advisor’s responsibility to focus the client’s attention on avoiding a structure which breeds conflict. For example, appointing an estranged stepson to act as Trustee for a stepmother is probably not a good idea. The stepson may be the remainder beneficiary of the trust, creating an inherent conflict of interest. Moreover, he may be less disposed to adequately provide for someone who is not his blood parent.

Ownership of Family Businesses and Properties - Even though 90% of American businesses are family owned, 70% do not survive the second generation and less than 10% survive to the third generation. (18) A large part of this low survival rate is due to family conflicts.

Many entrepreneurs intend to pass down their businesses to one or more designated individuals who will run their business after the entrepreneur’s death or retirement. But because the business is often the largest single asset of the estate, the owner may also pass some of the ownership in the business to other family members. Passing ownership of a family business to those who are inside and those who are outside the family business will create an inevitable conflict. This conflict evolves from a number of sources, including:

• During the owner’s lifetime the owner has been able to make sure that there is peace in the family and serve as the "benevolent dictator" of the family business. Unfortunately, this powerful role disappears with the entrepreneur's death or incapacity. Sibling rivalry and other issues then begin to come to the fore, particularly between those who operate the business and those who are outside the business.
• Business outsiders feel that the compensation and perks provided to the insiders are "excessive." Outsiders will question the business decisions (e.g., capital expenditures) of the insiders even when they know little about the business’s operations or competition. Outsiders often believe that the income paid to them should match the compensation paid to the insiders.
• Meanwhile, the insiders (who often feel they are working much too hard) resent that their sweat is increasing the value of the business interest of the outside family members who are continually asking for more and more income to which they are not “reasonably entitled.” The insiders often fail to see that the outsiders have a right to a return on their family’s investment in the business. Many family businesses have paid inordinate legal fees because of these conflicts and/or have been forced to sell the business to alleviate the problem.
• This conflict is inevitable as each business owner attempts to direct his or her own financial destiny and feels increasingly unable to do so because of common ownership with other family members. This is not a matter of "good" and "bad" family members. It is a matter of increasingly different life goals - a normal part of life.

The solution lies in setting up a structure in the estate plan which assures that those in the business own and control as much of the business as possible, while giving outsiders other assets so that they can effectively control their own financial destiny. Equalizing bequests using life insurance is often a necessary element of this planning. This planning process traditionally must be done during the entrepreneur’s life so the entrepreneur can dictate the terms to family members.

Creating Disincentives - The client drafts a will which severely restricts the benefits to a spendthrift son. The son wants to money today. The son may feel that he should challenge the client and/or trustee’s decisions and demand more funds. Except for the expense of his legal fees, there may be no disincentive to challenging the restraints in his inheritance. Clients should carefully consider placing provisions in their estate planning documents to discourage such challenges. For example:

• The will could contain a no contest clause which provides that if an heir challenges the estate plan and loses the contest, the heir loses all benefits from the plan. No contest clauses are not permitted in some states.
• Any will and trusts could broadly indemnify the fiduciaries for actions taken in good faith and provide that all legal costs for the defense of their actions be paid from trust funds. A trust might provide that such costs of defense are specifically paid from the income of the trust. Thus, a contesting heir might be in double jeopardy. The heir would be incurring his own legal fees and see a reduction of his or her income stream to fund the cost of the trustee’s legal fees.
• The estate plan might provide that an individual fiduciary is liable to beneficiaries only if their acts or omissions were deemed by a court to constitute gross negligence or intentional misconduct.

However, when the above provisions exist, they may also help protect a less than scrupulous trustee from being held liable for his or her actions. To provide a counterbalance to the above protections, the client should consider:

• Giving someone the ability to remove trustees without cause. (19) Obviously, if the spendthrift son had the power he might keep removing trustees until he found one who would do his bidding. In such an instance, the removal power could be placed in a “trust protector” who has no beneficial rights in the trust.
• Having more than one trustee. If there are multiple trustees, it reduces the possibility that the trust will be purposely mismanaged.

Summary

While divorce and conflict may be inevitable parts of human existence, there are ways to minimize their impact in an estate plan. The avoidance of transfer taxes has become less of an issue for more clients. Clients recognize the conflicts they and their friends have seen in other estate plans. As a result they are increasingly demanding an emphasis on methods which are designed to reduce conflicts among their own heirs.

Author: John J. Scroggin, J.D., LL.M. is a graduate of the University of Florida and is a nationally recognized speaker and author. Mr. Scroggin has written over 300 published articles, outlines and books, including The Family Incentive TrustTM.