3 financial challenges of blending families
Getting divorced and remarried is complicated enough without factoring in children and family finances. Read on to learn how you can blend well and thrive.
Since "The Brady Bunch" first aired on ABC in 1969, blended families have become increasingly common. In fact, the Pew Research Center reports that in 2010, 42% of 2,691 adults surveyed had at least one step-relative and 13% had a stepchild.
Whether they include stepchildren, half-siblings, grandparents raising kids or some other family structure, blended families often create more complicated financial considerations when it comes to estate planning, saving for college and paying taxes.
"Good financial planning can't fix a dysfunctional family, but bad planning can create dysfunction in situations where it need not be," says Wistar Morris, principal and client strategist with the wealth management firm Signature in Charlottesville, Va.
Here's a look at three of those situations, as well as strategies for working through them. Of course, every family's finances are different, so it's often smart to discuss yours with a financial planner, estate attorney, accountant or other professional.
Taxes are especially complicated for families going through a divorce, according to Mela Garber, a partner in New York accounting firm Anchin, Block & Anchin. For instance, when one spouse moves out of the house during a separation, that can complicate the spouse's capital gains tax when the house is sold because it's no longer a primary residence.
Determining which parent gets to claim the kids as dependents is another sticky tax situation for some divorced families. "Sometimes divorce or separate maintenance agreements will specify that each parent will take a dependency exemption in alternate years," Garber says. "The child dependency on its own doesn't generate that much tax benefit for higher-level income earners, but some credits like child care tax credits can be only taken by the person who takes the dependency exemption."
When a relative takes care of a grandchild, niece or nephew, he or she can claim that child as a dependent without legally adopting the child if the relative provides more than half of the child's support and meets other IRS criteria.
2. Saving and paying for college
Non-nuclear family structures add an extra layer of complication to student aid, loans and 529 college savings plans. For purposes of the Free Application for Federal Student Aid, or FAFSA, the assets and income of a step-parent married to the custodial parent do count toward the expected family contribution, according to Mark Kantrowitz, senior vice president and publisher of Edvisors.com. This could potentially lower that student's aid eligibility even if the stepparent doesn't intend to contribute to the student's tuition, and there's a prenuptial agreement establishing that fact.
"The only way to exclude the income and assets of the spouse is for that spouse to not be a spouse," Kantrowitz says. "Schools would be suspicious if a couple got divorced soon before college."
Divorced couples should also look at any 529 college savings plans, because if a noncustodial parent is the owner of a 529 plan, distributions from that plan can affect the student's aid eligibility. "Usually you can transfer ownership," Kantrowitz says. "If the state doesn't allow it, you just move the plan to a state that does allow it and change the account owner. You can keep it in that state or move it back."
3. Estate planning
Remarriages in particular can complicate estate planning. "One of the most common techniques in estate planning is a marital trust or QTIP (Qualified Terminal Interest Property) trust that is set up to benefit a surviving spouse for their lifetime," Wistar says. "The remainder goes to the children."
But if the new spouse is much younger, adult children may worry that their inheritance will go to support a stepparent instead of flowing to them. (Just look to Cinderella for a cautionary tale of not providing for one's biological children after death.)
"If there's a 25-year difference between the new spouse and their parent, and all those assets go into some type of trust to support the stepparent, there can be real resentment," says Joe Heider, regional managing principal at Rehmann Financial in Westlake, Ohio. "Their inheritance has been delayed by a generation."
If the biological parent is still insurable, Heider continues, he or she could potentially avoid this situation by purchasing additional life insurance and putting it in an irrevocable trust for the biological children. "The (surviving) spouse inherits the home and assets, and they've provided for the children in the form of life insurance," he says.
Updating beneficiaries on life insurance or retirement accounts is an important part of estate planning because beneficiary designations trump wills or trusts. If the policyholder forgets to remove an ex-spouse from a life insurance policy following a divorce, the ex could get life insurance money instead of the deceased's children or new spouse.
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