In Australia, when it comes to Estate planning, one of the key concerns for many parents is how to protect their child's inheritance from a future spouse in the event of divorce or a relationship breakdown. While parents want to ensure their children are financially secure, they also worry about their assets being at risk due to future potential marital discord between their child and spouse. Fortunately, there are various legal strategies available to safeguard your child’s inheritance from potential claims by a spouse. Here’s how you can approach this delicate issue.
Use of Trusts
Establishing a family trust is one of the most effective mechanisms for protecting a child's inheritance. A discretionary trust allows the assets to be held on behalf of the child without giving them direct ownership, thereby reducing (but not entirely eliminating ) the risk that the inheritance will be considered marital property in the event of divorce or separation.
In a discretionary trust:
- The trustees have control over the distribution of the trust's assets, which can be adjusted based on circumstances.
- The beneficiary, in this case your child, does not directly own the assets but may receive distributions purely at the trustees’ discretion.
- This structure can protect the assets from claims in a divorce proceeding because while the spouse may argue the inheritance should be part of the property settlement, but they will have a harder time claiming ownership if the assets are in a trust.
This is a complex area of the law and every case turns on its facts. Generally speaking, if it can be established that the trust is the meer puppet of the child in the Family Law proceedings, the assets of the trust will form part of the matrimonial asset pool. However, if it is found that the child is indeed merely a beneficiary of the discretionary trust (and they have received distributions prior), the Family law Courts have long considered the beneficiary’s interest in the trust as a financial resource rather than the assets of the trust form part of the matrimonial asset pool. However the law on this area is changing as evidenced in the recent decision of Woodcock & Woodcock [2022] Fed CFam 1F 173 where the Court was asked to determine whether a Husband’s interest as a beneficiary in intergenerational discretionary trusts could be considered part of the matrimonial asset pool. The husband argued against the inclusion, citing his lack of control and absence of a right to income or capital. On the other hand, the wife argued that subpoenas should be granted to obtain trust documents in order to ascertain whether the husband’s interest in the trust constituted an asset or a financial resource. Subpoenas were granted, and the Judge made a preliminary ruling that, despite lacking control over the trust, the husband had “influenced its operations.”. Consequently, the Judge concluded that the husband’s interests “are property that his wife can claim.” While the Judge did not determine the division of the trust’s value among the beneficiaries, it is evident from the decision that the ability of parties to safeguard assets through discretionary trusts is now being challenged.
Binding Financial Agreements (BFAs)
Encouraging your child to enter into a Binding Financial Agreement (BFA), commonly known as a prenup or postnup, is another approach to safeguarding their inheritance. A BFA can outline how assets will be divided in the event of separation or divorce, including stipulations about the inheritance.
Key features of a BFA include:
- It is a legally binding document that must be signed by both parties with independent legal advice.
- The BFA can specify that certain assets, such as the inheritance, will not form part of the joint property of the parties but instead is to be quarantined and retained by the party who received the inheritance.
- If structured well, it can prevent future disputes regarding the division of assets.
However, BFAs are not without risks. They can be challenged in court on a number of grounds, so it’s essential to seek experienced legal advice from one of our Accredited Specialists at the firm.
Gifting vs. loaning the inheritance
Another approach is to loan the inheritance to your child instead of gifting it outright. In this case, you (as the parent) or a trust you control can lend the inheritance to your child under a formal loan agreement, rather than giving it as a gift.
Here’s how this works:
- The loan agreement should be properly documented and executed as a binding legal arrangement.
- If your child’s marriage or relationship breaks down, the loan can be repaid to you or the trust, rather than being treated as an asset of the marriage.
- This structure can help to avoid the inheritance being treated as part of the joint property pool in family law proceedings.
However, loan agreements need to be handled carefully. They should have clear terms, including repayment provisions, to ensure they stand up to scrutiny.
Be mindful of joint ownership
Many parents give gifts to their children in the form of property or shares in joint ownership. However, co-ownership with a spouse can complicate things, as these assets may be seen as part of the shared joint property of the parties to which they are each entitled.
To protect your child’s inheritance:
- Ensure that any inherited property or assets are kept in your child’s sole name.
- Encourage your child to avoid using inheritance money to purchase a family home or other joint assets, as this could make it more difficult to separate the inheritance from shared joint property.
Considerations for superannuation and life insurance
While trusts and loan agreements are excellent tools for asset protection, superannuation and life insurance are separate considerations. In Australia, superannuation doesn’t automatically form part of a person’s estate upon their death unless specified, and the rules governing its distribution can differ.
- Ensure your superannuation has a binding death benefit nomination in place, directing the payout to your child or a specific beneficiary.
- Similarly, for life insurance policies, ensure the nominated beneficiary aligns with your inheritance goals to avoid disputes later.
Updating wills regularly
A well-drafted and regularly updated will is an essential part of any inheritance protection strategy. In your will, you can create testamentary trusts, which only take effect after your death and can provide significant asset protection for your child's inheritance.
Key advantages of testamentary trusts include:
- The trustee has control over when and how the assets are distributed, allowing for flexibility.
- Assets in a testamentary trust are generally not treated as personal property, which can provide some protection from a child’s spouse in the case of a divorce.
Additionally, regularly updating your will ensures it reflects any changes in circumstances, such as new relationships or legal developments.
Seek professional legal advice
Inheritance protection is a complex legal area, especially in family law matters. To ensure that your child's inheritance is properly protected, it’s essential to consult a qualified estate planning lawyer. They can help you structure your assets in a way that minimizes risk and provides long-term security for your children.
Conclusion
Protecting your child’s inheritance in Australia requires careful planning and the right legal structures. Trusts, Binding Financial Agreements, loan arrangements, and clear wills are all valuable tools in safeguarding assets. However, these strategies should be tailored to your specific situation, and professional legal advice is crucial to ensure they are effective. By taking proactive steps, you can provide your child with the financial security you intend, while protecting those assets from potential claims in the future.
