My parents were divorced when I was three. Both remarried within a few years. Both had two children in their new marriages. So, when asked if I come from a large family, how do I answer? Technically I am an only child, yet when the topic comes up, I am quick to say I have three brothers and a sister. I don't qualify them as halves. They don't feel like halves to me.
This is the complexity of our society. Second marriages and blended families are the norm. If you're in a second marriage yourself, here are three questions you need to ask — and answer — when it comes to your retirement planning within the context of your current marriage.
Who gets what?
Suppose you are my father and his wife, and you have been married since I was three. How shall you divide your savings among your two combined children and me? Some would say equally. I've also heard a proposal of fractions; 1/5 to me and 2/5 to each of the joint children. There is a part of me that is offended at the thought of being only 1/5, but the financial planner in me thinks that is just as fair a way to do it as anything else.
What if you have no mutual children, yet your spouse has one or two from a previous marriage? Do each of your respective IRAs go to each of your respective children? What about the assets you accumulate together?
This may sound like more of an estate planning matter than a retirement planning matter, but it is both. Many people tally up all their assets to estimate their retirement income — but if one passes early, and a huge chunk of assets bypasses the spouse, then what? The surviving spouse's retirement picture may look quite different than what was expected. Add in a large age differential in your second marriage, and it gets even more complex.
Smart financial planning software allows you to designate beneficiaries for each account and model out exactly what happens to the retirement income based on the longevity of each spouse. It's important to build a retirement plan that can hold up under numerous "what if" scenarios. To do this testing accurately you have to know where each asset goes upon the death of the account owner.
Which accounts get used first?
When you are in retirement you are taking withdrawals. A good retirement plan shows you which accounts to withdraw from first, then second, etc. I have numerous couples with a 10-year or larger age difference. In many cases we intentionally use the older spouse's IRA first for tax reasons (Roth conversions, reducing future required minimum distributions, etc.)
If you're going to use a lot of one person's assets first, or use joint assets to pay taxes on Roth conversions, you better also make sure you have your beneficiaries lined up. I've seen wives (and husbands) who planned to leave a specific account to their child, but when we projected it out, that account was slotted to be used in the next 10 years, and the child would be left with little. When you model this out, often the most efficient spend down strategy isn't the one that results in meeting your bequest goals.
In many of these situations, if eligible, life insurance is the best solution. (Note, I don't sell life insurance.) Sometimes it is a life insurance benefit to go to the current spouse; sometimes to the children. The advantage of an insurance solution: You can specify the amount you want your separate or combined children to receive, and then build the premiums into your retirement income plan to see how feasible it is.
Who's in control?
As I was writing this article, my go-to life insurance agent Jeff Carman stopped by my office and shared his own story. In his second marriage, his wife has one child from a previous marriage. He said he wanted to make sure his wife didn't leave all her assets in his possession. He's a good guy, but he said it simply isn't right that she should rely on him to carry out her wishes. If she passes early, and he gets everything, he is now in a position to disinherit her child.
His solution? He had her set up an irrevocable trust funded with life insurance. His wife is the donor and trustee. She deposits funds to the trust to pay the life insurance premiums. Her child is the beneficiary. If both his wife and her child predecease him, he is the contingent beneficiary. In these situations his preference is to fully fund the life insurance over the first 10 or 15 years. Then you know what the child is getting and as a couple you are free to enjoy the rest.
I often see the standard bypass/survivor trusts used, where the decedent's assets are put in a bypass trust and the surviving spouse can withdraw income and sometimes principal, and when the survivor passes the remainder goes to the children. In these situations the surviving spouse often remains in control. That may be a solution, but life insurance may be a better one.
The key with all of these questions is to be intentional about it. Second marriages and blended families add complexity to your retirement planning. It can be modeled out and structured in a way that works for your situation. You just have to take it one step at a time.