Protecting your children's inheritance from divorce
Summary: Family gifting for a single child is straightforward, however where that child is married or part of a couple considering options which offer protection over the familial assets may be appropriate. |
Key take-out: A testamentary trust can be both a powerful tax planning and asset protection tool. |
Key beneficiaries: Family members. Category: Taxation, gifting. |
I recently wrote a piece exploring some alternate ways in which one might consider financial assistance to family members (see Four financial gifts for the family).
With increased cost of living pressures and, for many, an almost impenetrable home property market, it remains natural that parents may simply wish to offer lump sum gifts to alleviate life's financial strains on their children where it is in their capacity to do so. If not during their lifetime, this may instead manifest through their estate with the transfer of assets through a will.
Where a child is single, this can be a relatively straightforward notion, however where that child is married or part of a couple, considering options which offer protection over the familial assets may be appropriate.
While the divorce rate has somewhat stabilised over recent years, McCrindle's 2015 analysis of ABS data illustrates that around one-in-three marriages will end in divorce. Most will likely attest to good relationships with their sons or daughters-in-law, but underlying that will undoubtedly be a natural preference to keep family assets within the bloodline in the event of their child's relationship breakdown.
Where a financial advance is made to a child as a gift, that can later become part of the child's divisible assets in the event of a property settlement. This means that monies gifted in good faith can inadvertently end up in the hands of an ex-partner, unless appropriate mechanisms are put in place.
Of the divorce data, the average length of marriages was 12 years, highlighting that while it might be hard to imagine divorce when times are good, things can unfortunately change as time – maybe many years – goes by. Further to this, laws introduced in 2009 allow that de-facto couples can in the event of their separation seek property division through the court in the same way that applies to married couples. The definition of a de-facto couple, while it must be assessed on its individual circumstances, will broadly mean those living in a genuine domestic relationship of at least two years.
Loan vs gift
Rather than providing a straight financial gift, a loan arrangement between parent and their child may instead be considered, particularly where the amount is relatively significant. This ultimately allows mum and dad to be treated in much the same way as any other creditor and, in the event of a relationship breakdown, the monies are payable back to them without those funds forming part of the child's divisible asset pool.
A loan agreement can therefore be a straightforward and effective way of protecting assets in the event of a marital split. It is important to note however that – if it becomes necessary – the arrangement must be able to be validly demonstrated to be a loan, and so certain criteria should be met at the outset including but not limited to having the agreement in writing, duly signed by all parties. It is possible that the loan amount not have a fixed repayment date or interest payable, but it will be important to consider making all the conditions in the agreement at the time of the advancement, and to put the right documentation in place then and not afterwards. In order to ensure the effectiveness of the arrangement, advice should ideally be sought from a solicitor who would also draw up the formal written agreement covering the key criteria.
Understandably a parent might struggle with the discussion around why funds might be advanced in this way rather than as a clean gift. In my experience however, once the rationale around protection is stepped through, any potential offense is usually dissolved.
As always, speaking to an adviser about what it means for one's own circumstances and what is viable should remain at the forefront of consideration. A parent's natural desire to support their children is one thing, but ensuring that their own position and retirement plan can sustain it should first be assessed.
Testamentary trusts
A testamentary trust can be both a powerful tax planning and asset protection tool, and I will separately expand on their broader benefits in a follow up piece. When it comes to passing assets to beneficiaries after death, they can offer protection against the financial implications of relationship breakdown long after a will-maker's passing.
A testamentary trust, sometimes called a will trust, is be established through the will at the time of death and will essentially house the inheritances on behalf of the beneficiary rather than those monies falling directly into their hand. An inheritance that is held within a properly established and controlled testamentary trust is less likely to be the subject of a Family Court proceeding and therefore become a divisible asset of the child's in the event of a relationship or marital split.
While there is typically not an obligation on the beneficiary to maintain the testamentary trust, they would elect to retain the structure in order to have the continued ability to protect their inherited assets into the future (together with other benefits). The inclusion of testamentary trusts in one's will simply creates that option for the beneficiaries, so engaging them in the discussion and at the planning stage is a positive. Although there is a cost of establishing testamentary trust wills, it typically is not viewed as prohibitive in light of the possible long-term benefit.
As always, seeking specialist advice is paramount. And while wholeheartedly hoping that loved ones will not be faced with the stress associated with a relationship breakdown, both in an emotional and financial sense, it does not preclude taking reasonable precautionary steps when making financial gifts – either through one's estate or during their lifetime.
Carol Tawfik is a Certified Financial Planner and adviser with Affinity Private.