A family affair – protecting family assets
With 42 per cent of marriages ending in divorce, it’s important when advising wealthy clients to put mechanisms in place to protect family assets. Jenny Cutts provides a guide on relevant private client law for the family lawyer.
It is important when advising clients on divorce, separation agreements, cohabitation arrangements, and pre and post nuptials to make sure your clients and their families put in place mechanisms to protect the family assets and review any planning structure already in situ.
In this article, we will review the scenario of a married couple, Simon and Sarah, with their two adult children, Edward and Emma. Edward has two children and is divorcing; Emma is engaged to be married a second time, she has a child by her first marriage and will have two stepchildren once married.
We consider what estate planning the family can undertake to protect the family wealth whilst also balancing the complex family dynamics through the use of wills, trusts, different asset strategies and lifetime giving.
With a change in personal circumstances, Edward and Emma, and Simon and Sarah, should make wills or review the wills they already have in place.
Through the use of ‘immediate post death interest’ (IPDI) trusts and discretionary trusts the family can achieve the following:
- Simon and Sarah can add a layer of protection for any of their children (or grandchildren) who are at risk of a third party claim (such as a divorcing spouse) on their assets. The trustees will be able to make smart distribution decisions based on their children’s and grandchildren’s personal circumstances at the time.
- Edward (who is divorcing) can make sure his assets bypass his ex. After divorce, a will takes effect as if the former spouse had died unless there is contrary intention in the will (sections 18A and 18C of the Wills Act 1837). However, this does not take effect until the divorce is finalised with a decree absolute, meaning the former spouse could still inherit in the interim.
- Emma can use her will to protect her new spouse financially during his lifetime but ultimately ensure that the family money passes to her child. She can also take steps to mitigate the possibility of challenges to her estate under the Inheritance (Provisions for Family and Dependants) Act 1975 (IPFDA 1975). Her step-children could make a claim for a share of her estate under the IPFDA 1975 if she is treating them as ‘a child of the family’ (section 1(d) of the IPFDA 1975), and in any event if she is financially maintaining them (section 1(e) of the IPFDA 1975).
Solid letters of wishes behind each of the wills will leave the trustees with no doubt about how each member of the family would like their will trust/s to be administered. Such letters will also help the trustees negotiate a settlement with any claimants and potentially avoid the need for costly court proceedings.
A will covers a lot but not everything
Not all assets fall under the jurisdiction of a will. It is critical that the family review their individual assets to fully minimise third party claims against their estates. Pensions, life insurance policy proceeds and death in service benefits are good examples of where significant amounts of money can pass outside the authority of a will.
Simon and Sarah will need to review what provisions have been made for these assets and if nominations have been made in their children’s favour outright, they will need to alter these provisions to hold these assets in trust to help protect against third party claims and keep family money ’in the family’. This will avoid Edward receiving a significant inheritance mid way through any financial settlement negotiations.
Likewise, Edward and Emma should review what provisions they have in place and make sure any nominations they have made for these assets are no longer in favour of their ex-spouse. Thought will need to be given to who they would now like to benefit and on what terms.
Again, a careful letter of wishes to the Pension and Death in Service trustees, and the trustees of any life insurance policies will be invaluable.
Lifetime gifts and use of cohabitation and nuptial agreements
Lifetime giving is an important theme in any advice on wealth protection. It is simple and straightforward to make outright gifts, but such gifts will not benefit from asset protection. For small gifts this may not be a concern but where an extra layer of protection and control is required for more significant transfers, use of trusts need to be considered.
A discretionary trust will give the trustees complete flexibility to decide when, how much and to whom distributions are to be made. They can manage the trust assets and distributions to protect the family wealth over the long term, assisting beneficiaries through turbulent emotional and financial times and keeping the wealth in the family blood line.
However, whilst assets are better protected in a trust than if owned outright, trusts are still vulnerable on divorce. Under section 25(2)(a) of the Matrimonial Causes Act (MCA) 1973, the court must look beyond the strict property interests of the parties to the ‘other financial resources which each of the parties to the marriage has or is likely to have in the foreseeable future’. Beneficial interests under a trust are considered a financial resource.
The significance given to a beneficial interest depends on the extent of the underlying assets, their value and the likelihood that they will be received in the foreseeable future. A discretionary trust for all of the children with no pattern or expectancy of distributions for any child will stand a better chance of protection than one where a child has clear and regular distributions, or the settlement has a ‘nuptial’ character. Trustees need to be alert to this and act accordingly.
Other key protective steps are the use of cohabitation and nuptial agreements to help protect family money. Often, wealthy families have wealth planning strategies in place in which your client has an interest but may not have been given (or be interested in) the details. When advising your client on these agreements, you need to find out exactly what assets have already passed down the family line and what the potential wealth prospects are for your client; otherwise such agreements could be held invalid for lack of disclosure.
Advising any client on their family matters is never straight forward. The private client and family lawyer need to work together to help protect the family assets against third party claims from the outset. And on that note, have I mentioned balancing the tax consequences yet?
This article was first published on the Law Society's Family Section on 15 February 2017