Susan Midha, a partner at law firm Adams & Remers, outlines a case study illustrating the potential pitfalls facing a HNW woman with a son who is planning to marry for the second time.

Susan Midha, a partner at law firm Adams & Remers, outlines a case study illustrating the potential pitfalls facing a HNW woman with a son who is planning to marry for the second time.

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.