Financial Decisions Following Separation and Divorce
Helen was an existing client who at the age of 37 went through the emotional trauma that separation followed by divorce typically brings. However, she knew it was also a time to make some of the most important and rational financial decisions of her life.
With finances after divorce being often initially complex, she wanted a full review of her financial affairs and protection of her 3-year old daughter, Emily, was a priority.
We updated information about her revised personal financial situation including her monthly income, monthly outgoings and how much money she saved in pensions and other accounts.
Following in-depth discussions an affordable budget was agreed. We calculated the financial shortfalls in the event of short-term and long-term illness or disability, critical illness and death. We considered her employer’s sick-pay arrangements and existing death-in-service provision by her employer. After discussing the available options, we agreed on the following course of action.
Helen was advised to make a new will and state the preference that her sister be appointed guardian of her daughter in the event of premature death. Her ex-spouse had not proved reliable in maintaining a relationship with the child, Emily, during the period of separation and Helen didn’t think it would be fitting for him to have custody under the circumstances.
However, the decision would not be hers; it is up to the Court to decide who the guardian should be, and the judge would decide based on the child’s best interest.
Helen was advised to explain her reasons in a letter including relevant court records or any other evidence of her ex-husband’s unsuitability as a custodial parent. The letter should be given to her sister as preferred choice of guardian, to be used as evidence of her wishes in the case of a court proceeding.
Helen appointed her sister as her Attorney should she became mentally incapacitated.
Prior to the divorce settlement we advised Helen to change her expression of wish nomination of beneficiary*. Previously her ex-spouse had been nominated and Helen was advised to change her nomination to the trustees of a family discretionary (pilot) trust. Her sister and mother could be trustees with Helen asking the that they use funds for the benefit of her daughter.
If Helen had nominated her daughter directly there would be is an increased risk that the trustees of the Scheme would make the payment to:
- her ex-husband as surviving parent or potential guardian on the daughter’s behalf
- a child trust account where it could be held until the child is aged 18
Neither of these would be a desirable solution as Helen would not want her ex-spouse to have any control over how the money is spent and if it was held until age 18 it would mean that the fund could not be used for Emily’s benefit whilst growing up.
We also recommended that she change the nomination of beneficiary for her pension policies and deferred pensions. The position here is the same as for the death-in-service set out above. Here a separate discretionary trust was recommended with the trustees nominated to become legal owners of the death benefit proceeds and guided by an Expression of Wish to apply funds in favour of Emily as needed.
In order to help Helen build up an emergency fund referred too below we recommended that she temporarily reduce her pension contributions.
*The death benefit under death-in-service and personal pension policies will normally be payable at the discretion of the trustees or insurer who will usually be guided by the member’s Letter of Wishes. However, it is not binding.
Protection Shortfall Planning
Helen’s daughter was clearly dependent on her mother’s income. Therefore, death or long-term illness posed a threat and Helen was keen to ensure that her daughter would continue to enjoy the financial support to provide for her care, education and lifestyle.
We undertook shortfall calculations taking in account her net earnings, pension fund value and death-in-service amount as well as her outstanding mortgage. This enabled us to decide on the amount of cover needed.
Mortgage Protection (decreasing term insurance)
It had been agreed that Helen would keep the marital home and she increased her repayment mortgage to buy out her ex-spouse’s share. The home was in her preferred location of choice and she believed that by remaining there it would cause the least amount of disruption for both her and her child.
The existing mortgage protection and term insurance policies were arranged on a joint life first death basis. This meant that her former spouse was the primary beneficiary if she died first. Helen did not want her your ex-spouse profiting from her death and as part of the settlement it had been agreed that this policy would be replaced.
We recommended mortgage protection insurance with added critical illness cover for a sum assured which decreased over time to match the outstanding liability. This ensured that there would be funds to repay the mortgage on death or diagnosis of a qualifying critical illness during the repayment term.
We arranged the policy to be set up with a split trust which would enable payment of the sum assured to the trustees on death or to her upon diagnosis of a critical illness. This ensured that in either scenario there would be enough funds to repay the mortgage.
For the balance of her capital protection needs on death we recommended a 22-year term insurance policy written under trust on a similar basis to those described above. The term was set to dovetail with Emily becoming financially independent following further education.
Income Protection Insurance (Permanent Health Insurance – PHI)
It is a legal requirement that employees receive Statutory Sick Pay (SSP) when they are absent from work due to illness and it is payable for up to 28 weeks. Helen’s employer pays a contractual excess in addition to SSP to make up her full pay for a period of 3 months and then half-pay thereafter up to 6 months absence.
We recommended Helen to:
- build an emergency fund to cover for shorter-term sickness income shortfall between 3 and 6 months absence from work.
- take out income protection insurance to cover extended absence beyond 6 months. It is designed to provide cover if she can’t earn an income due to illness or injury and kicks in after a deferred period; in this case 6 months. It ensures she continue to receive a regular income until she retires or can return to work. The maximum benefit that is offered by most insurers amounts to 55% of gross income but it is paid tax-free.
PHI is not the same as critical illness insurance, which pays out a one-off lump sum if you have a specific serious illness.
As a non-smoker, being in good health and without a hazardous occupation or hobbies, Helen benefited from standard underwriting rates on all of the policies recommended.
How did Helen benefit from our Advice?
Helen gained ultimate peace of mind knowing that detailed plans had been put in place to ensure that upon her premature death Emily would have a proper plan for her care and a financial safety net.
We continue to work Helen in reviewing on an annual basis how her changing personal and financial circumstances impact on her needs and objectives.
This story is based on a real client situation. Names have been changed for data protection reasons.
Trusts and Tax Planning are not regulated by the Financial Conduct Authority.
Will writing is also not regulated by the Financial Conduct Authority.
The case study is purely for information purposes and does not constitute advice. For advice based on your individual needs and circumstances please contact us.