Monday, August 15, 2005

Estate Planning to Protect Your Child's Inheritance from a Failed Marriage

In British Columbia, the Family Relations Act, RSBC 1996, c. 128, governs how assets are divided on a marriage breakdown. If an asset is owned by one spouse, and is used for a family purpose, that asset may be taken into account by the court when the family assets are divided between the husband and wife on the breakdown of the marriage. Even if one spouse inherited the asset, if it is used for a family purpose, the other spouse may have an interest in the asset on the breakdown of the marriage.

This is not to say that the spouse who inherited the asset will always be required to share the inheritance equally: the courts may take the fact that it was inherited by one spouse, and apportion the value of the inheritance unequally in favor of the inheriting spouse.

What can you do if you are planning on leaving a large amount of your wealth in your will to a child whose marriage you believe is at risk of breaking down?

Instead of leaving your child his or her inheritance outright in your will, you could put some or all of the inheritance into a trust. A trust involves having one or more persons, called trustees, hold the assets for the benefit of others, called the beneficiaries. The trust could either be set up during your lifetime with funds that you will not require, or in your will. You would appoint one or more trustees to hold the assets for the life of your child. The trust would have several beneficiaries, including your child. You might want to include your child’s own children and grandchildren. The trustee would have complete discretion to make distributions to or for the benefit of your child out of the trust assets. This is called a discretionary trust.

The advantage of a discretionary trust is that your child does not own the trust assets. Arguably, only those distributions that the trustee has made to the child before the breakdown of the marriage are family assets subject to the claims of the child’s spouse. Although, the child’s interest in the trust could be a family asset, the value of the child’s interest in the trust is small, because the child cannot force the trustee to make any further distributions to the child. If on a marriage breakdown the court ordered that future distributions to the child must be shared with the spouse, the trustee could decline to make any further payments.

If the discretionary trust is set up in your will rather than leaving the inheritance to your child outright, there may also be some tax advantages to your child by having the trust’s income taxed separately in the trust.

There are trade offs. Your child might prefer to have his or her inheritance outright to use as he or she wishes, and may resent the fact that you set up a trust instead. If the trust is set up in your will, the child could even apply to court to vary the will to get his or her share outright. Accordingly, it is recommended that if you are planning to set up a trust for your child, you discuss this with your child first.

There will be additional costs to have a proper trust drawn up. There will also be the costs of administering the trust, including trustee fees and accounting fees. It probably is not worthwhile to set up a trust with a very modest inheritance.

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