Children can all too often be locked out from receiving an inheritance due to issues that can arise from blended families
Whether it is due to divorce or death, there are now numerous blended families in the UK. A blended family consists of a couple, their children from previous relationships and the children they have had together.
Such a family structure can create complex financial planning issues which, left unresolved, can mean wealth not being passed on to its intended recipient.
The following case study illustrates how quickly children can be locked out from getting an inheritance due to issues that can arise from blended families.
Tom and Michelle are happily married with two children: William, aged 12, and Hugo, 11. Michelle receives £200,000 in inheritance from her father, which she invests. She intends to use the money to pay for her children to go to university and for a deposit on their first home.
Michelle falls ill and passes away a year later. She made a will and left all her wealth to Tom. A few years later, Tom meets someone else, Alison, and decides to remarry.
Alison already has two girls: Amelie, aged six, and Alexa, four. Tom and Alison decide to use Michelle’s inheritance on extending their family home instead of paying for the boys to go to university.
A few years later, Tom is involved in a road traffic accident and passes away. Tom did not make a will and, therefore, all his wealth automatically goes to Alison. William and Hugo contest this decision, feeling some of their father’s wealth should have passed to them.
Due to the ongoing animosity, Alison decides to ask William and Hugo, who are no longer dependants, to leave the family home, and no wealth is passed on.
Shielding the inheritance
Michelle would not approve of her inheritance being spent by Tom and his new wife on a house extension and would be devastated if she knew her boys had been disinherited.
One of the simplest ways Michelle could have avoided this situation is if she had invested the money she had earmarked for William and Hugo’s further education in a trust. This would have shielded it from Tom and his new wife’s actions.
There are two types of trust that can be considered by parents to make sure wealth is passed to the right people and spent correctly.
A discretionary trust gives a parent more control with regards to when and how assets within it are distributed and to whom.
The trust is guided by the parent providing a letter of wishes to selected trustees, which will set out their wishes. Although the letter of wishes is not binding, it does provide the trustees with an insight into the settlor’s preferences.
The other option would be to use a bare trust. This means the children who are beneficiaries will be entitled to their respective share in the trust at age 18.
The benefit of this type of trust for blended families is that the beneficiaries are fixed, so once the trust is declared, it is not possible to add (or remove) any. That said, the children will have access to that money as soon as they turn 18 and they will be able to use it in any way they choose.
There are differences in how inheritance tax is applied to these trusts. Discretionary trusts will be subject to the IHT chargeable lifetime regime, while assets gained from a bare trust are treated as a potentially exempt transfer.
With either trust, where the person making the gift lives for seven years thereafter, the gift falls outside their estate for IHT purposes. The discretionary trust can attract further IHT charges every 10 years and when money is distributed to beneficiaries.
Responsible will planning
The other obvious method of ensuring the right assets are passed down to the right people is through writing a will.
Being a widow or widower and then remarrying is not uncommon. However, this case places responsibility with Tom to ensure his children are financially looked after on his death.
Tom could have written a will to ensure his assets were fairly divided should anything happen to him.
On his unexpected death, his assets (and any life assurance) could have been fairly divided so both Alison and his two sons received some money.
Alison’s decision to disinherit her stepchildren is all too common and highlights the importance of planning, as you never know what is just around the corner.
Rachael Griffin is tax and financial planning expert at Quilter