Divorce – Managing life changes - Protection solutions using a trust

Summary

When a couple are divorcing it is often necessary to attempt a reconstruction of the couple’s finances in two (potentially unequal) parts. This will be made more complicated if there are young children involved. An important element of that reconstruction would include consideration of adequate Protection cover for both individuals. In this article we consider what a typical set of circumstances might look like  and consider some key areas for Protection planning.

Facts and analysis

At the time of the divorce, the main components of the family finances will need to be identified and decisions taken on how to move forward with either the equivalent or potentially changed provision.

If there are minor children involved, consideration would need to be given to adequate maintenance provision for them not only as a consequence of the divorce but also should the principal carer and financial supporter die following the divorce.

The issue is probably best considered by looking at a case study:-

Jane and David, both aged 42, are going through a divorce. They have two children, Ben (8) and Scarlett (6), who both now live with Jane.

Of primary concern to both Jane and David is the long term well being of their children. Jane is concerned about  the loss of any entitlement to David’s  death in service benefits.  David has a number of pension policies and some accrued entitlement under a former employer’s pension scheme and but comparatively little life cover.

Under the terms of the proposed financial settlement, Jane will take ownership of the house, which is mortgage free, that she and the children live in.

Jane’s only other asset is a bank deposit account containing £2,000.

Also, they have agreed that David will make monthly maintenance payments of £800 to Jane until the children reach age 18 or finish education. 

You are considering the wider picture of Jane and David’s current protection arrangements, and central to that is the important question of continuity of the maintenance payments.

One of the key questions concerns the adequacy of any financial protection should David die before the children reach age 18 or finish university, and this is where the requirement for Protection cover becomes initially most prominent.

Next steps

In commencing a review, an essential consideration is to look at current protection arrangements and identify any gaps in the cover when considering revised financial aims and concerns.

The case study assumes that the house is mortgage free. This would not always be the case, and could be connected with life cover that could be retained or remodelled.

David’s death would clearly have a significant impact on Jane’s ability to support their children.  A simple approach here could be for David to effect a policy on his own life, and write that in trust for the children perhaps including Jane as a Trustee. This could involve either a contract designed to pay a lump sum, or perhaps a Family Income Benefit as this is designed to pay a tax free income for a set period of time. 

Alternatively, Jane could take out the policy on David’s life, as she is likely to have an insurable interest on his life, due to his obligation to make maintenance payments. The term of the policy should match the term of the maintenance agreement, and potentially could extend until the children have finished university (e.g. 21- 23) with payments of £800 a month payable in the event of David’s death. The requirement for a trust for a policy written on that basis would need to be decided by Jane and David. If seen as a requirement, then the most likely beneficiaries would be the children with Trustees selected from the close family.   

To cover the children’s dependency on Jane, she could consider a Term assurance policy, perhaps if affordable with critical illness to provide her children with a lump sum should she die or suffer a critical illness. Once again, writing the policy in trust could help direct the funds to the children, potentially appointing their prospective Guardian as a Trustee.

The term of the policy could extend to retirement or to cover the period of her children’s dependency.

A trust could ensure that, in the event of a claim, the policy proceeds would not be included in Jane’s estate for inheritance tax purposes and to allow the surviving trustees to receive the policy proceeds without waiting for a Grant of Representation.

Using a split trust would enable Jane to retain any critical illness benefit if selected and seen to be a requirement.

Additional considerations

Whilst a divorce doesn’t invalidate a Will in the same way that (re)marriage does, there is a strong probability the change in the relationship between Jane and David would mean that their Will provisions may also need to change. A review would be good practice.

A Divorcing couple will probably be using different legal firms to advise them. Hence in taking forward the need to arrange protection orientated cover for the (former) couple it would make sense to contact the solicitors acting for both parties. Not only will this benefit the client(s) in terms of ensuring a more seamless interaction between formal arrangements, it brings with it the opportunity to develop working relationships with other professionals operating in a complimentary discipline.

From an initial contact in respect of one case, in the longer term it raises the possibility of more day to day work with family solicitors, and the on-going ability to develop more connections such as by invitation to local law society events.

From a purely practical perspective, professionals of all disciplines will appreciate help with other needs driven by a divorce e.g. pensions,  re financing mortgages, rearranging life existing cover etc.

Important information

This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2020.  It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice.  Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients.  You should always seek appropriate legal or other professional advice.