Susan Midha, a partner at law firm Adams & Remers, discusses case studies illustrating the potential pitfalls facing HNW woman contemplating marriage.

Susan Midha, a partner at law firm Adams & Remers, discusses case studies illustrating the potential pitfalls facing HNW woman contemplating marriage.

Case Study 1

Clare is in her early 40s and is divorced with a 12 year-old son, Charlie, at boarding school. She travels considerably with her job in financial services and she is in a long-term relationship with a man she would like to marry.  She is keen, however, to protect her six-figure financial settlement from her first marriage and her assets - home, pension, shares - and to protect her son’s financial future.

Clare may be of the view that the main threat to Charlie’s financial future would be on her remarriage but that is not necessarily the case.  There can be other matters that deplete wealth for cohabitees.

Finances, particularly in relation to a shared home, are often difficult to keep totally separate.  Who paid the deposit when the property was purchased?  Who paid for the double glazing or, when the boiler broke,  paid for the repairs?  Does one partner pay the mortgage and the other all the outgoings?  Did one partner give up secure accommodation in reliance on promises made by the other?  In these and many other circumstances, on the sale of the property arguments can arise as to how the proceeds of a sale should be split even if it is in the name of only one of the partners.

The need for clarity

A declaration of trust can help to prevent such problems by making a clear statement of how the house and contributions to its upkeep etc. should be dealt with and, if it is jointly owned, what is intended to happen if one of the partners ceases to occupy it.  Where there is a possibility of children being born after the declaration of trust has been made, consideration should be given to whether that would impact on the arrangements.

Moreover, where a couple live together for more than two years, in what used to be called, rather quaintly, a “stable illicit union”, the survivor of them can make a claim on the death of the first to die if “reasonable” provision isn’t made for them under the will.

And that is in addition to the tax man taking his cut.  With a rate of 40 per cent over the nil rate band of £325,000 ($515,000) inheritance tax (IHT) can seriously damage your wealth - or at least that of your heirs - so taking steps to save IHT while not affecting your own standard of living can make sense.  

A little-known but very useful tool in this regard is the education trust.  This would ring-fence funds for Charlie’s education and has the additional benefit that those funds immediately fall out of Clare’s estate for IHT purposes, even before they are used.  The seven-year period usually applicable before gifts are out of one’s estate doesn’t apply.

An added bonus is that, provided it was not set up specifically to defeat a claim on divorce, the trust is unlikely to be regarded as a resource available to Clare in financial proceedings. 

The prenup

As marriage is on the cards, a prenuptial agreement is key, to try to ensure that the intentions of bride and groom are clearly expressed and available to the court to consider in the event of a divorce.  While this may not be romantic there’s around a one-in-three chance of marriage ending in divorce, so a reasonable likelihood that a prenup will be useful as evidence.

Since a prenup, though an increasingly important factor to be considered,  is not binding on the court, before marrying Clare may wish to consider taking some additional steps to protect her son and his inheritance.

When Clare marries her previous will is automatically cancelled, so she will need to consider putting a new one in place.  While she could do so leaving everything to Charlie outright, that would be missing a trick.

By benefiting her husband with the right to income which can be taken away from him by the trustees of the will and passed to Charlie, Clare can make sure her estate benefits from the spouse exemption (so it would be free of tax) and also make it more difficult for her husband to bring a claim on her death.

The need for a guardian

Whether or not she marries, Clare should also appoint a guardian for Charlie either in her will or in a separate deed.  Many parents see this as even more important than what happens to funds on death, to avoid a court having to decide who would look after their child if they could not. 

Clare may feel that her partner is the right person to look after Charlie on a day-to-day basis but unless he has parental responsibility for him, he will have no legal standing for doing so.  And there’s Charlie’s father, Clare’s ex, to consider.  Ensuring that everyone knows her wishes for Charlie’s upbringing is crucial, and while he is under 18 this may be the best gift Clare can give him.

It’s not possible to know what the future holds.  But, whether or not she remarries,  in the event of her premature death, if Clare had secured for Charlie a mentor, a good education and an estate which is protected as far as possible from the ravages of tax, she could feel satisfied that she had done her best to look after him, if the unthinkable happened. 

Case Study 2

Svetlana is in her mid-thirties is planning to get married later this year for the second time. Sadly, her mother who lived in Monaco passed away recently; her mother’s estate is valued at over £5 million and Svetlana is the sole beneficiary. Svetlana has a son from her first marriage and would like to have more children with her new husband. She would like to protect her inheritance for the benefit of her son.

For Svetlana, three things are likely to affect the assets she can pass on to her son:

-       UK inheritance tax

-       Non-UK death duties

-       Marital breakdown

If Svetlana’s father was UK-domiciled, or she was born in the UK, or if Svetlana herself has decided to make the UK her permanent home or has actually lived here for 17 years out of the last 20, she will be assessed as either UK-domiciled or deemed domiciled, and she will be subject to UK inheritance tax on her assets world wide in either case.

At 40 per cent on anything above £325,000 ($511,000), UK IHT is not inconsiderable. While there are reliefs available (for example, on business assets), the most important one for Svetlana is the spouse exemption which will be available to assets transferred to her new husband, if he to is UK-domiciled or deemed domiciled.

By making a will which gives funds to her husband in trust, with the executors/trustees having the power to bring her husband’s interest in the trust to an end, Svetlana can ensure that the spouse exemption is available but still direct funds to her son on her death.  That would only reduce the potential IHT if Svetlana died before her husband.  If she survived him, she would need to rely on lifetime planning to maximise funds for her son.

If Svetlana’s husband is not UK domiciled or deemed domiciled, the spouse exemption is limited to £55,000, so in the event of Svetlana’s death (and presuming she has not been previously widowed as well as divorced) only £380,000 of her estate will be tax free and the balance will be taxed at 40 per cent.  In that case, Svetlana should consider being very proactive in relation to how she organises her finances during her lifetime.

The first precept of IHT planning

The first rule of lifetime IHT planning is to keep assets out of your estate, and wherever possible retain access to them.  Svetlana should follow this rule with regard to her mother’s estate.  If Svetlana’s mother was, as seems possible, not domiciled in the UK, Svetlana should consider varying her mother’s will retrospectively to redirect the funds she has inherited into an excluded property trust.  As long as the funds are kept offshore – for example in a Jersey bank account rather than a UK one – Svetlana will be able to have access to them without their forming part of her worldwide assets for UK IHT purposes. 

A common misconception is that excluded property trusts have to have offshore trustees, with the expense that that entails. The trustees can be UK-resident, although if Svetlana were herself non-UK-domiciled, an offshore trust could provide additional advantages.

If Svetlana is herself non-UK-domiciled but plans to remain resident in the UK then she could in addition set up a similar trust for her own non-UK assets, to keep them out of the UK IHT net if and when she becomes deemed domiciled after 17 years residence here.  This could also help minimise Capital Gains Tax on those assets in the future.

The threat to Svetlana’s son’s inheritance through marriage can come from two sources: divorce or Svetlana’s death.  A prenuptial settlement, while not entirely binding, is increasingly persuasive in English courts and is an obvious course for Svetlana and her fiancé to explore.  It may also be of help in the event of Svetlana’s death, since her husband will have the right to reasonable provision from her estate, similar to what he would have been entitled to on divorce.  Funds in trust (such as an excluded property trust) are not always taken into account in either case, but it is preferable to have put them in trust before the marriage.

The other area that might warrant consideration – if Svetlana and her husband are not UK domiciled and not planning to stay UK resident - is where they marry.  Other countries have a different approach to financial provision on divorce and “forum shopping” – trying to pick the best legal jurisdiction – is becoming increasingly common.

So lots for Svetlana to consider, but if her objective is to protect her son’s inheritance, failing to plan before the marriage may be planning to fail.

This article is not intended to be a full summary of the law and advice should be sought on all issues.