Second marriages have been called relationships where eternal hope beats experience. Many second or third marriages have circumstances that give rise to unique financial planning issues when compared to first marriages. These include:
- the couple may have children from a previous marriage
- there may be a significant difference in the level of wealth between the individuals
- there may be support obligations to former spouses or children of previous relationships
According to Statistics Canada, approximately 40% of marriages end in divorce. There are significant provincial variations as 44% of Quebec marriages end in divorce, whereas the Newfoundland rate is only 22%. These figures do not take into consideration common-law couples who end their relationship. There are various financial planning issues related to second marriages, including:
- financial planning issues that can be resolved prior to marriage
- prenuptial agreements
- estate planning issues
- ongoing issues with former spouses
Although conventional wisdom suggests that second marriages should be more successful than first marriages, the statistics do not support this view. It has been suggested that a person in a second marriage may walk away from an unhappy relationship, as the couple may not have children together or since they have already experienced divorce, there is no fear of the unknown.
After twelve months of living together, a couple is considered to be married for purposes of the Income Tax Act, but not for provincial family law issues. As a general rule, common law couples may have support obligations if they separate, but assets are only equalized upon separation for married couples. For example, in Ontario an unmarried couple may be considered spouses for purposes of support if they have lived together for at least three years or had a child together, but not for equalization of assets.
We shall review various financial planning issues facing a fictional couple who are about to marry and have the following background:
- the husband has two sons from a previous One is a young adult who has left home while the other is a teenager who resides with his former spouse. He owns a home and has investments worth approximately $3,000,000. A key objective of this individual is to leave a significant inheritance to his two children from the previous marriage. He currently pays both child and spousal support
- the wife has one grown child and a teenage daughter who still lives at home. She owns a home but has no other material assets
A common issue for this type of blended family is the husband wants to ensure that not only his spouse has financial security upon his death, but that his children from the previous marriage receive a significant inheritance. Although the couple has four children from previous marriages, there may not be a desire, especially by the husband, to split his assets equally between the four children since the husband entered the relationship with significantly more assets. The husband may also have a concern that upon his death, his current spouse may remarry or change her will and this may result in his sons not receiving the inheritance that was planned.
If the father wishes to provide his sons with a significantly larger inheritance than the daughters of his current spouse, it is important the spouses discuss the issue. If it is not resolved to the satisfaction of both spouses, it may create ongoing friction in the relationship.
Financial Planning Prior to Marriage
One of the first steps to be taken by an individual who is about to enter a second marriage is to remove the former spouse from all legal documents. This would include:
- upon remarriage, previous wills are no longer valid. New wills should be prepared for both spouses that incorporate the agreed upon estate plan
- beneficiaries must be updated on various legal documents, such as life insurance policies, Registered Retirement Savings Plans, pensions, powers of attorney and living wills
The couple should resolve two issues – do they intend to sign a prenuptial agreement and how will they resolve estate planning issues related to their adult children?
Prenuptial Agreement – In second marriages, both parties may have concerns that arose during the break up of their previous relationships. Even if a couple decides not to enter into a prenuptial agreement, it is important to have a frank discussion in which they disclose all of their assets and liabilities and share their views on how to develop an estate plan that considers the needs of both the spouse and any children from a previous marriage.
The family law legislation has a very simple premise. Upon divorce, married couples have two options – they can split their assets based on the legislation, or they can opt out and sign a mutually agreed upon contract to divide the assets. If the decision is made to draft a prenuptial agreement, it is crucial to follow these steps:
- both parties must make a full and complete disclosure of their assets and liabilities
- both spouses must hire the services of a lawyer. It is totally unacceptable for the husband’s lawyer to draft a contract and have both parties sign the agreement. Likewise, they should not prepare a contract by themselves without the involvement of lawyers
- the signing of the prenuptial agreement must be totally voluntary. It is unwise for individuals to tell a future spouse that they refuse to get married unless the contract is signed, i.e., “take it or leave ”
- both spouses must abide by the terms of the agreement
In a first marriage, most estate plans are reasonably straightforward, especially if the assets of both spouses are approximately equal as at the date of marriage. A common estate plan has each spouse leaving most of his or her assets to the surviving spouse and upon the death of that spouse; the assets are distributed to their children. This strategy may not be appropriate in the case of second marriages.
Let’s return to our fictional couple where the husband has investments valued at three million dollars and wishes to give both of his sons a million dollar inheritance and any remaining funds would go to the surviving spouse. This approach does not treat his new spouse’s children as beneficiaries. This may be reasonable to the husband, perhaps not so much for his spouse. Let’s review a number of scenarios on how the inheritance can be distributed to the sons of the first marriage and possible problems with each approach:
The husband’s will divides his estate into thirds – 1/3 for each son and 1/3 for his current spouse.
Under the family law legislation, upon the death of a spouse, the surviving spouse can elect to receive either the greater of the inheritance as outlined in the will or an equalization payment based upon the rules of the family law legislation. Depending upon the length of the marriage and the assets accumulated, the spouse may elect to receive an equalization payment rather than the inheritance outlined in the will. The net result is the children may not receive their million dollar inheritance.
The husband’s will leaves all of the assets to his spouse and she agrees to update her will so that upon her death, her estate will pay the million dollar inheritance to both of her deceased husband’s sons.
Even though the surviving spouse agrees to the plan, she could change her mind. Perhaps she believes it is more reasonable to treat all four children of prior marriages equally. By simply changing her will after her husband’s death, his estate plan objectives have been totally eliminated. The problem may be compounded if she remarries.
In addition to these scenarios, there are a number of potential estate planning mistakes that a couple entering their second marriage can make. These would include:
Designating someone other than the surviving spouse to receive the RRSP can result in a significant tax expense for the estate. Assume a husband with an adult son from a previous marriage has an estate of a million dollars which is represented by $500,000 of RRSPs and $500,000 of other assets. If the goal was to split the estate equally between the current spouse and his son, one alternative would be to leave the RRSP to the son. Quite often after a divorce, the man may name his son as the beneficiary of his RRSP and may not update this designation upon his subsequent marriage. Once the husband dies, the RRSP would be paid directly to his son as the beneficiary of the RRSP. However, the income tax on the RRSP income must be paid in the deceased’s final return. Assuming a 40% tax bracket, the $200,000 tax liability would be payable by the estate which would reduce the amount payable to the surviving spouse to $300,000.
Joint Ownership of Assets
Assume an individual owned assets valued at $1,000,000 and his will left 50% of the estate to his son by a previous marriage and 50% to his current spouse. However, the assets were jointly owned by the husband and his spouse as a strategy to reduce probate fees. Upon the husband’s death, the assets would transfer directly to the spouse. The net result is the spouse inherits a million dollars and the son may receive nothing.
Resolving Estate Planning Issues
Two strategies that may resolve issues relating to the couple’s estate are the use of a spousal trust and/or life insurance.
Spousal Trust – One strategy that can provide for the financial needs of the current spouse and ensure an inheritance is passed to the children of a previous marriage is to establish a spousal trust. Upon the individual’s death, the assets will transfer on a tax-free basis to a spousal trust. Upon the death of the surviving spouse, the assets will be transferred to the selected beneficiaries of the trust, i.e., the children from the first marriage.
A spousal trust must ensure that the surviving spouse is entitled to receive all of the income from the trust and no other person can receive any of the capital from the trust, while the spouse is alive.
Life Insurance – Insurance can be an effective tool to fund the inheritance of children from a previous marriage or pay the tax liability resulting from an individual’s death. One of the problems with this approach is the cost of the life insurance. As individuals age, they may find term life insurance quite costly.