Help your clients protect assets from a child's ex-spouseBy Rosemary McCracken | May 14 2013 03:52PM
Your baby boomer clients are probably well aware that marriage does not necessarily last forever. Some have gone through divorces, and they may now be concerned that their assets will end up in the hands of a child’s ex-spouse.
One of the first steps will be to ensure that their children protect the assets they bring into marriages or common-law relationships. In some cases, those assets were augmented by gifts from your clients.
“The children of the boomers are often well-educated but they may be burdened by student loans, which are a big drag on getting started in life,” said Carol Bezaire, vice president, tax and estate planning, at Mackenzie Financial in Toronto. “And many are not finding work in their specialties.” Your client may be tempted to help out a child and that child’s spouse or common-law-partner with a gift of money for the down payment on a home. But this should only be done upon careful consideration.
Legislation governing the division of property upon divorce and the breakup of common law relationships differs from province to province. “And it is constantly changing,” noted Audrey McFarlane, a financial advisor with Edward Jones in Victoria, B.C. “There are general strategies your client should consider to protect assets from a child’s divorce, but he should also talk to a family law expert and a tax accountant. The lawyer may need to look into family law outside the client’s province if a child has relocated to another part of Canada, because the rules in the jurisdiction where the separation took place generally govern division of assets.”
In most provinces, the assets accumulated during the marriage, as well as the increase in the value of assets that were brought into the marriage, are subject to a 50-50 split upon divorce. Spouses are generally allowed to keep the value of the assets that each bought into the marriage.
Marriage contracts and co-habitation agreements for couples in common-law relationships are valid in every province, and are one of the strongest ways of protecting a partner’s assets. They should document exactly what assets – apart from the family home – the parties want to share and what they don’t want to share, and set out the terms for division of assets.
But most marriage contracts are drawn up for second marriages, Ms. Bezaire said. “Young people entering a first marriage often assume they don’t need a contract because they are just starting out and have few assets. They don’t realize that assets can grow throughout the marriage, and sometimes in the hands of one spouse.”
The family home has a unique place in family law, and a marriage contract will not protect it from division upon dissolution of a marriage in most jurisdictions. “So it may not be a good idea for your client to come up with the down payment on his child’s home,” Ms. Bezaire said.
However, she added, the client can document his gift with a loan agreement that states that this sum of money is to be used as a down payment and that if the home is sold due to the breakdown of the relationship, the amount will be returned to your client. “The client may consider forgiving this loan in his will, even if the marriage does break down,” she said, “making it part of the child’s inheritance.”
But Christine Van Cauwenberghe, assistant vice president of tax and estate planning at Investors Group in Winnipeg, warned that if no payments are made and no demand is ever made for them, a court may decide that the “loan” was really a gift towards the family home is sharable in the event of a divorce.
The client can also make a gift of money to the child but this should be done before a marriage takes place, Ms. Bezaire said. “Document the gift with a declaration of gift form that states the client is transferring the sum of money and income from it to the child. And have the child keep that money in a separate account.”
This may be easier said than done. “The child may well say that this money is not doing her and her spouse any good in an account when they need a home,” Ms. Cauwenberghe said. “And if she takes that money out of the account and uses it as a down payment on a mortgage, it will be sharable in the event of a divorce.”
With small businesses accounting for 43% of all jobs created in the Canadian private sector between 2001 and 2011, according to Industry Canada data, steps should be taken to protect family businesses in the event of a child’s marriage breakdown. “When your client brings his child into the business as a shareholder,” Ms. Bezaire said, “if that child holds shares personally, the child’s ex-spouse may be entitled to 50% of the shares. Your client can buy the ex out, or he can hold the shares in a family trust in order to protect them from division in the event of a divorce. This will also protect the shares of the business from being subject to the probate process, and a family trust will allow your client to funnel dividend income to the trust, which will then flow through to the family members who are the trust’s beneficiaries.”
An inter vivos trust – a trust created during your client’s lifetime – will ensure that the assets are never owned directly by the child and considered family property. “By putting my assets into a family trust, they are no longer my assets,” said Kirk O’Brien, vice president and market manager at BMO Harris Private Banking in Kelowna, B.C., “Therefore I avoid having them pass through my will and I reduce the risk that my will will be challenged in jurisdictions that allow a child to contest a parent’s will. However, we are seeing challenges in the courts around ‘fraudulent conveyance’ – assets that put into a trust with the intention of avoiding ex-spouses.”
With some exceptions, Canadian family trusts are deemed to dispose of their assets every 21 years, and the trust is taxed accordingly. But Alison Oxtoby, director of wealth services with BMO Harris Private Banking in Kelowna, B.C., noted that there are steps that can be taken before that time arrives to help mitigate the pain “such as adding another trust to stagger the tax bill.”
If a client plans to leave a child an inheritance, it is important that the child have a marriage contract or co-habitation agreement in place. “Many of our clients tell their children that they will need to enter into a marriage contract before the parent will consider leaving them bequests in their wills,” Ms. Oxtoby said.
A discretionary testamentary trust is another way to protect a client’s estate in the event of a child’s divorce. Like inter vivos trusts, testamentary trusts will ensure that the assets are never owned directly by the child. “The trust can be set up in your client’s will with a clause that states that ‘any assets to which my child is entitled will be held in trust,’ ” Ms. Bezaire said. “The client may want to name a third party as trustee to prevent his child from being influenced by the spouse to drain the trust.”
Inter vivos trusts and testamentary trusts are taxed differently, which could factor into the client’s estate plan. “Inter vivos trusts are taxed at the top marginal tax rates,” Ms. Oxtoby said, “whereas testamentary trusts have access to graduated tax rates. So there can be significant tax advantages to incorporating testamentary trusts into wills.”
And a testamentary trust can be named the beneficiary of a life insurance policy. “This would ensure that a child does not come into possession of a large sum of money upon the policy’s payout,” Mr. O’Brien said.
A drawback to making a trust the beneficiary of an insurance policy, Ms. McFarlane said, “is the potential to lose the ability to protect the cash surrender value from creditors during the life of the insured because the trust is not considered to be part of the ‘protected class’ of beneficiaries [spouse, children, etc.]. If creditor protection is a concern, the client should consult a lawyer.”
“There are unlimited permutations and combinations to how a trust can be set up, depending on how locked up the client wants his money to be,” Ms. Van Cauwenberghe said. “The trust can withhold payouts until the child reaches a certain age, with subsequent payouts over a number of years. And a contingency beneficiary can be named in the event of the child’s death, so the assets would then go to your client’s grandchild.”
Mr. O’Brien noted, however, that a rigid payout schedule could result in a claim from an ex-spouse. “Say the trust gives a fixed payment of $2,000 a month to its beneficiaries for the rest of their lives. The ex-spouse could claim that the income or capital from the trust was part of the family assets and demand payment of $1,000 for the rest of her life.”
“A frequent mistake we see made by parents who are concerned about the stability of their children’s marriages,” Ms. Oxtoby said, “is providing for trust payouts at predetermined ages – often 25 or 30, sometimes as high as 40. Your clients should keep in mind that most divorces take place after the age of 40. It would be awful to witness a required distribution of a trust to a child in a failing marriage.”
Maintaining a trust
And a trust only makes sense, Ms. Van Cauwenberghe noted, if your client has sizable assets to leave because of the costs of maintaining a trust, including trustee fees that vary across the country. “In Ontario, for example,” she said, “the suggested guidelines are 2.5% on capital and income receipts, 2.5% on capital and income disbursements, and 2/5th of 1% on the gross average value of the assets under management.”
Mr. O’Brien added that the person or persons who hold power of attorney for your client are essential in ensuring that his estate plans are carried out. “If the client chooses the wrong person, all the planning can be for naught,” he said. “The reality is that many of us will be incapable of managing our own affairs at the end of our lives. The person who holds power of attorney can deplete the assets the client intended to be passed onto heirs. The client needs to make sure the person he chooses is trustworthy. And he needs to keep in mind that this person’s spouse may have a big influence over him.”