Silver divorce trusts

While it can, of course, be distressing to start again later in life, in many cases silver divorces can be less problematic. For example, there are unlikely to be young children involved so there’s no need to make child maintenance arrangements. Couples divorcing later in life may have built up more resources than younger couples, making it easier to ensure that everybody’s needs are met.

Silver divorces often come at a time when families would ordinarily be looking to their estate planning (eg putting tax-efficient wills in place). For many families, particularly those who are separating amicably, there can be an opportunity to incorporate estate planning as part of the process.

Trusts and divorce

Trusts are already a common tool in divorce settlements. For example, when one party agrees to provide a property or cash sum for their former partner on the proviso that it’ll eventually end up with their joint children (rather than passing to the former partner outright and potentially being left to a spouse).

The trust will be held for the children until the death of their parents or upon certain events, such as a remarriage. This protection becomes even more important where second marriages and blended families are involved, ensuring that each party’s family is provided for.

Estate planning

While the use of trusts on divorce for asset protection purposes is well established, it’s possible to think ahead and to incorporate some estate planning as part of the process.

Tax rules for trusts

Since 2006, most trusts established during the lifetime of the settlor are subject to inheritance tax (IHT) at certain points under the relevant property regime. IHT charges can arise as a result of:

• Entry charges: When funds are added to the trust
• Periodic charges: On every 10-year anniversary of the trust 
• Exit charges: When capital is distributed from the trust

The charges arise on the value of the trust over and above the settlor’s nil rate band, which is currently £325,000, reduced by the value of any other trust contributions in the preceding seven years.

Any funds added to a trust in excess of the nil rate band are subject to an immediate IHT entry charge at the rate of 20%. This is then topped up to 40% if the settlor dies within seven years.

However, divorce can offer a unique opportunity to add much larger sums to a trust, without incurring this entry charge.

Transferring more into trust

Maintenance payments

Any payments made for the maintenance of the former spouse/civil partner, or for the children of the marriage (up to the age of 18 or finishing full time education), are exempt from IHT. However, this exemption is limited to the amount required for maintenance and only up to the specified age. It’ll therefore be of limited use for most silver divorcees whose children have already left full-time education.

The Inheritance Tax Act

A wider exemption is offered by section 10 of the Inheritance Tax Act, which provides that transfers that aren’t intended to confer any “gratuitous benefit” on any person can be made free of IHT. Circumstances include:

• Made in an arm’s length transaction between unconnected persons
• The kind of disposition one would expect to find in an arm’s length transaction between unconnected parties

The majority of divorce settlements are negotiated between the parties rather than one party deciding to gift something to the other, or to their children. It’s well-established that a payment made as part of a settlement isn’t intended to confer a gratuitous benefit on the other. This is still the case where the payment in question is made to a trust rather than outright to the other party.

Court orders

Court orders go a step further. The argument here is that there’s no transfer of value at all. In paying the amount that they’ve been ordered to pay, the individual in question is simply complying with the order rather than making a transfer of value. No transfer of value means no IHT.

Putting it into practice

The effect of the above is that no IHT applies to the transfer of up to any amount provided the sums required are either:

1. Maintenance, in accordance with section 10
2. Paid as a result of arm’s length negotiations
3. Ordered by the court

One party to a divorce can therefore transfer much more that £325,000 into trust, with no entry charge (and no further IHT if they die within 7 years).

Other estate planning

While trusts are an important part of estate planning, it’s important not to overlook the basics, such as wills and lasting powers of attorney, all of which will need to be reviewed and updated following a separation. If you have any questions, get in touch.

Case study: Beryl and Jim

Beryl and Jim are both 75 and were married for 50 years.

They jointly own their home worth £500,000. Most of the remaining family wealth, the sum of £4.5 million, is in Jim’s name, following the successful sale of his business a few years ago.

They decide to divorce and simply split everything down the middle - £2.5 million each. Beryl dies shortly afterwards and the IHT on her estate is £870,000 (40% of £2,175,000, after deduction of her nil rate band).

If, however, Beryl and Jim had taken some estate planning advice as part of the divorce process, they could have structured things very differently.

If Jim had, instead of transferring £2.5 million to Beryl, only transferred £500,000 and put the remainder into a trust, the IHT on Beryl’s death would have been £270,000 (40% of £675,000) – saving them £400,000.

Although the trust will be subject to periodic charges (and potentially exit charges if funds are withdrawn), these charges are a maximum of 6% on the value of the trust fund over and above Jim’s nil rate band. The trust would need to be running for many years before the charges exceeded the 40% IHT payable on Beryl’s death.

Read the latest edition of Private Affairs for updates in private wealth law.