By Charlotte Macdonald, Senior Associate Solicitor in the International and Cross-Border Team at Stone King LLP
In our society, ‘blended families’ are becoming more common. For those working in the international private client sector, it is important to be aware not only of the practical difficulties that a ‘non-traditional’ structure can bring to families following a death, but also of how legal and tax systems can treat this type of family differently.
The definitions of a blended family vary, but the term generally means a family in which the parents have children from an earlier relationship. For example, mum has two children from her first marriage, dad has one child from his first relationship, and now mum and dad have one child together.
Although not all the children and parents are legally related to one another, this doesn’t mean that they see themselves as anything less than family. It is common, therefore, for parents to leave assets to both their legal children (adopted and blood relatives) and their step-children.
England and Wales
Where there are assets in England and Wales only, the two most common scenarios that we come across when drafting Wills for clients with blended families are as follows:
The parents leave all their assets to one another on the first death. On the second death, the surviving parent leaves all their assets to all the children equally. The parents trust that the surviving spouse will not change their Will to disinherit their step-children.
Each parent establishes a life interest Trust under the terms of their Will. They name their spouse as the life tenant of the Will, with their legal children named as the remaindermen. The spouse has the right to any income produced by the Trust assets and to occupy any property owned by the Trust during their lifetime. On the death of the surviving spouse, the assets pass to the children. In this way, the surviving spouse is looked after, but there is no worry that they will change their Will to disinherit the children or spend all of the assets.
Under English and Welsh law, we uphold the doctrine of testamentary freedom. This means, broadly speaking, that we can leave our assets to whomever we wish on death. So, the parents can estate plan as above.
From a UK Inheritance Tax point of view, these options are fairly straightforward, and the usual tax allowances will be available (subject to the usual rules): the Nil Rate Band and Residence Nil Rate Band, which is available when a property is left to ‘lineal descendants’. Importantly, in the UK, the definition of lineal descendants includes step-children.
Europe and further afield
In other parts of the world, testamentary freedom can be limited by forced heirship rules. In many European countries, whose legal systems are based on civil law, it is obligatory for a parent to leave their assets, or a percentage thereof, to their children. For example, the position in France strongly favours parents leaving their assets to children both from a succession and taxation point of view.
Under French domestic law, children are protected heirs and are entitled to a percentage of assets on death (the amount that a child is entitled to is dependent upon the number of children the parent has). In the presence of children, a spouse is not a protected heir, and it is not possible to leave all assets to the surviving spouse.
It is worth noting that step-children are not treated as legal children, and are instead treated under succession and tax law as an ‘unrelated beneficiary’.
Under French law, Inheritance Tax is levied on the beneficiary rather than the estate, the rate dependent on the amount received, and the beneficiary’s relationship to the Deceased. Children receive the largest tax-free allowance (up to €100,000) and lowest tax rates (5%-45%). Step-children, as unrelated beneficiaries, receive the smallest tax-free allowance (€1,594) and pay tax at the highest rate (60%).
Law at European level (EU Succession Regulation 650/2012) does allow for an election of the law of the Testator’s nationality to govern the succession of their estate – meaning, for example, that a British person could elect ‘British’ law (if they are most closely connected with England and Wales, it is this law that will be chosen) to apply in their French Will. Whilst this means that in a blended family scenario the parents could choose to leave everything to one another on the first death and then equally to the children/step-children on the second death, it will not achieve equality. This is because the step-children will be taxed at a very high rate compared to the children, meaning that the legal children will walk away with a much larger amount net of tax than the step-children.
It is also important to mention that the effectiveness of an election of British law may be reduced if any of the Deceased or their children are EU nationals or residents (Article 913 of the French Civil code).
Planning and estate administration
Whether parents can attain equality between their children and step-children will be dependent upon their circumstances, and it can be challenging for blended families to achieve.
Creative thinking when it comes to appropriation and Deeds of Variation may help if the type of issues raised above have only come to light following a death – it will depend upon the jurisdiction and the local notary/Lawyer with whom you are working as to which solution may work.
The recognition and taxation of Trusts can also be problematic in civil law jurisdictions, so any planning using Trust structures must be carefully examined before being utilised.
If working with blended families with assets in both the UK and overseas, it is important to recognise the difficulties that can be encountered when trying to achieve a ‘fair’ outcome for all.
For more information, please contact the International and Cross-Border team at Stone King LLP – Charlotte Macdonald, Dan Harris, Raquel Ugalde, Emma Seaton, Bryony Anning, or Marina Emmanouel – either by calling +44(0)1225 337599 or by emailing email@example.com.
This article is featured in the summer 2023 edition of our quarterly news digest, Entitlement. Click the image below to download your free copy of Entitlement for more informative articles.