Mixing and Matching: The Financial Ins and Outs of Blended Families

In February 2018, the Vanier Institute of the Family reported that there were nearly 518,000 stepfamilies, or blended families, in Canada in 2016. This total accounted for 12% of couples with children. The institute further broke down stepfamilies as simple (only one spouse brought children into the blended marriage - 61%) and complex (both spouses brought children into the marriage - 39%).

These statistics reflect that the Brady Bunch is not the uncommon family situation it once was. Blended families have gone mainstream.

Blended families bring a host of issues, from family integration to increased stepsibling rivalry to financial and tax issues. Today, I will address the key tax and financial issues.

Financial assets coming into the marriage

Unlike the typical marriage, where there are often minimal financial assets and the couple begins the slow climb to build those assets, blended families tend to occur later in life, where one or both parties have not only children but also substantial assets.

Both spouses have often gone through divorces and are very cognizant of protecting their assets. This results in some of the following issues:

1. In many cases, while both parents love and treat each others’ children as their own, the reality often is that one or both parents want to protect some or all of their assets for their biological children.
2. One spouse feels the other spouse should treat the stepchildren and biological children equally when it comes to finances and inheritance.
3. The children of one or both spouses fear their family’s assets or inheritance will be taken by the new spouse.

These are very complicated financial and emotional issues and are a minefield that must be navigated with care.

Key areas of financial and tax concern

The financial issues for a blended family are too numerous for a single blog post. Today I will cover the following issues:

1. The money discussion
2. Marriage contracts
3. Wills and powers of attorney
4. Prior documents
5. Estate planning

The Money Discussion

In a blended marriage, saving and spending habits are typically already in place for each spouse, and those habits may not be the same. The spouses’ financial assets may also be significantly different. Each spouse will have thoughts on their legacy. It is thus practical and responsible to discuss these issues before you enter into the blended marriage.

These discussions typically center on how expenses are shared, whether to open joint bank accounts, how assets purchased after the wedding will be owned, how to fund the children’s RESPs, and how to plan their estates.

While some of these topics can be contentious, it is always better to discuss financial topics before the discussion is forced on you.

Marriage contracts

Marriage contracts are very important in blended marriages where there are substantial assets and private corporations brought into the marriage. These agreements (technically known as prenuptial agreements when signed before the marriage), deal with support and division of property if the blended marriage dissolves or one spouse dies. It is also important to get advice on how family homes and other assets brought into the marriage are treated under the family law of that province. These variations in law may tie back directly into the marriage contract.

Discussing a marriage contract can be very unsettling for people entering a first marriage. In second or third marriages, the sobering reality of divorce proceedings often makes both parties more amendable to discussing and negotiating a marriage contract. It is suggested the contract take the form of a prenuptial agreement (i.e.- entered into before the marriage, not after). 

Many experts recommend discussing your marriage contract with your children (especially if they are older and responsible) to possibly alleviate their concern that their inheritance will be “taken” by the new spouse.

Wills and powers of attorney

Readers of this blog know I have written ad nauseam on ensuring you have an updated will and ensuring you have financial and personal care powers of attorney (POAs), the latter covering medical treatment and healthcare treatment. The POA gives authority to an individual to act as your agent.

Updating or preparing these documents is vital when entering into a blended marriage. This is because most provinces have rules relating to wills upon divorce that can affect or void how your current will is distributed. While provincial laws may or may not negate provisions related to your former spouse, you clearly in almost all cases want to remove any reference to your ex-spouse.

Your POA document will also often designate your former spouse, so you will want to update these documents and not leave it to provincial law to assign this key role.

As noted above, each province has different rules in respect to wills and POAs, so legal advice should be obtained.

Prior documents

It is important to review documents to determine if beneficiaries need to be updated. Some of the more important documents to review include the following:

1. Life insurance polices
2. RRSPs
3. Pension plans

The last thing most people want to do is leave their insurance, RRSP or pension plans to their former spouse.

Estate planning

Estate planning is complicated enough in a first marriage; second or third marriages multiply the risks and complexity. Say you leave all your assets to your spouse because their will also has provisions for your children. But as noted above, if your ex-spouse remarries, certain provinces may void their prior will and leave your children out of luck. Alternatively, they could change their will and “write out” your children. How do you ensure your wishes are undertaken?

Spousal trusts

Spousal trusts in general will allow your assets to flow tax-free into the trust for the benefit of your spouse. Your spouse, subject to terms of the trust, will be the beneficiary of the income and capital for as long as they live, and then the terms can specify that the remaining assets are transferred to your children and stepchildren. These trusts are complicated, and you need to engage a lawyer who specializes in estates to assist you with your planning. It is also prudent to have your accountant work hand in hand with the estate lawyer to cover off your financial and tax issues.

Direct gifts in your will

Another option is to leave distinct inheritances to your spouse, biological children and stepchildren in your will, create separate trusts for each, or do both. Again, tax planning is imperative, as there may be deemed tax dispositions on the gifts to your children if the inheritance is not a cash-only gift.

Gifts during lifetime

Depending upon your financial situation, it may be simpler to give gifts to your children while you are alive to help with home purchases, grandchildren’s educational needs or any other expense. Before undertaking this strategy, you should ensure you create a financial plan to ensure you do not put your retirement or your spouse’s future living expenses in jeopardy.

Insurance

Many people in blended marriages are conflicted or feel pressure to ensure their new spouse is taken care of, their biological children receive the inheritance the parent envisioned, and their stepchildren receive a similar inheritance to the biological children or at least something substantial. As there is only so much money and assets to go around, it is common to use life insurance to build additional liquidity to cover or assist in paying estate taxes, ensure vacation properties or businesses do not need to be sold, and provide funds for inheritance equality for children and stepchildren.

The above is a very cursory review of some of the complex issues facing the parents of blended families. As noted throughout the post, it is essential you obtain proper family, estate and tax advice as you navigate the financial issues of a blended marriage.

This post covered steps you can take to protect your assets when getting married - steps that are taken well in advance of a potential divorce. These days, as we weather the economic effects of COVID-19, we’re facing a challenge to our portfolios that few could have anticipated. But there are things you can do to protect your wealth. Have a look at this recent COVID-19 roundtable discussion featuring top economic and investment professionals.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

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RRSP/RRIF Spousal Transfers on Death - Not so Automatic – Be Careful you don’t Create a Family War

Most people are aware that upon their death, their RRSP/RRIF can automatically transfer tax-free to their spouse’s RRSP/RRIF if their spouse is the beneficiary of their plan. The advantage of this spousal rollover is that the income tax on the value of the RRSP/RRIF is deferred until the surviving spouse passes away.

However, if the surviving spouse has other ideas and does not transfer the proceeds of the RRSP/RRIF to a plan of their own, the possibility exists that they could end up keeping the proceeds of the plan while leaving the related income tax liability to be paid by the deceased’s estate. While this can be an issue for any family, for blended families, this has the potential to ignite World War 3.

I recently attended the Ontario Tax Conference. The participants were lawyers and accountants, most of whom specialize in income tax. I know a room full of accountants and lawyers talking tax, what could be more torturous. However, there was actually a very outgoing and passionate presenter by the name of Christine Van Cauwenberghe of the Investors Group. 

Christine presented the technical details relating to this issue, from the mechanics of the “refund of premiums” to the administrative withholding requirements for financial institutions. But, in simple terms, this is what you need to understand.

When you designate your spouse as the beneficiary of your RRSP/RRIF, they will receive the proceeds of your RRSP/RRIF directly. It will then be his/her responsibility to transfer the entire proceeds to their RRSP/RRIF. If they do that, the bank issues the tax receipts in their name and there are no income tax consequences, end of story. 

However, your spouse has no legal obligation to transfer these funds to their RRSP/RRIF. In fact, where your spouse rather use the funds immediately, does not get along with your natural children or is from a second or third marriage and has his/her own children and/or does not get along with their step-children, they may decide to take the money themselves and not transfer the funds to their plan. In these circumstances, the tax receipt for the RRSP/RRIF will then be issued to the deceased’s estate. While the spouse may be held jointly and severally liable by the CRA for the related income tax, if the estate has enough assets, the CRA will typically go after the estate for the taxes, not the spouse.

In order to avoid this potential minefield, Christine suggests that you designate your estate as the beneficiary of your RRSP/RRIF, with a clause that provides two alternative options:

Option 1: The beneficiary (your spouse) chooses to elect with the executor(s) to have the RRSP/RRIF amount taxed in their own name as a refund of premiums. Under this option, the spouse receives the entire RRSP/RRIF proceeds and typically transfers the proceeds to their RRSP/RRIF and the estate assists in filing an election. The required election form is Form T2019, however, you would probably not want to name a specific form in the will, only that there is an option to elect.

Option 2: If the spouse does not agree to the joint election, then they are only entitled to an allocation of the RRSP/RRIF funds net of the associated income tax liability to be incurred by the estate.

A disadvantage of designating your estate as the beneficiary of your RRSP/RRIF is that the funds will be subject to probate in most provinces. Some people feel that the probate fees (1.5% of the value of the RRSP/RRIF in Ontario) are a relatively small cost in order to prevent the potentially disastrous result of your spouse taking the entire proceeds of your RRSP/RRIF and leaving the estate to pay the related income tax.

If your spouse and children do not get along, or you have a blended family, you may wish to review this issue with the lawyer who drafted your will.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.