Picture this: the Smiths, are a high net worth couple in their 40s that are separating. Mr. Smith owns a $5 million dollar business and was the financial decision maker of the household, and Mrs. Smith is a homemaker that supported Mr. Smith for the past 20 years as he built up his business. They have two kids and more than $700,000 in registered retirement savings accounts.As a result of their separation agreement, it has been decided that Mrs. Smith is entitled to receive spousal and child support payments totaling $20,000 per month, as well as an equalization payment of $3,000,000 for her share of family net assets earned during the marriage.
Clients like Mrs. Smith are likely to need the services of a financial advisor to help educate them on how to invest and protect their divorce settlement, says Neil Maisel, a partner with Crowe Soberman LLP, a Toronto-based accounting firm, who specializes in business valuations in family law cases. “All of sudden this person has come into a lump sum of money but has no idea what to do with it.”
In the event that Mr. or Mrs. Smith decides to get remarried, they will both likely need advice on new ways to invest or protect their estates going forward, adds Maisel. “The way a divorce is settled today could have serious implications on assets and legacy going forward.”
While advisors may not be involved with their clients’ separation proceedings directly, they can still be a resource of information, says Fareen Jamal, principal lawyer at Jamal Family Law Professional Corp. “The more understanding clients have of the financial issues in their divorce, the stronger their finances will likely be coming out of it.”
From insurance to portfolio investments, here are the areas an advisor should make a part of the divorce conversation to ensure clients remain protected:
Adjusting financial plans
In high net worth divorce proceedings, the costs of litigation become expensive. Advisors should tell their clients to curb unnecessary expenses at this time, says Jamal. “Legal fees can build up and even the wealthiest clients will have to adjust to a new financial reality once they are separated.”
For clients like Mrs. Smith that are financially dependent on their significant others, they could end up with a lump sum settlement and that will become their “financial nut” going forward, says Maisel.
“If these clients can’t return to the workforce, their financial nut has to perform for them,” says Maisel. “Financial advisors are responsible for helping these clients find the balance between budgeting for daily living and ensuring their nut remains relatively untouched.”
That makes “risk tolerance” one of the most important drivers in constructing a portfolio for a newly divorced client, adds Jamal. “A client with a single income may have a different tolerance for risk than the couple did.”
Regardless of how investment savvy a client is, the risk tolerance of a single income home is likely to be very low, she adds. “A single client is going to have a multitude of priorities to meet and as a result, can’t handle the swings in the portfolio he or she did when in a couple.” Among those priorities are budgeting for support payments, while meeting other priorities such as paying taxes and saving for retirement.
Once parties in a separation have agreed to the amount of child support and/or spousal support one of the parties receives, insurance policies should also be written into the agreement to ensure those payments are protected, should the payor die or become disabled.
However, insurance is often the afterthought during separation procedures, says Karen Stewart, founder of Calgary-based Fairway Divorce Solutions Ltd. “It’s up to advisors to help clients think beyond the divorce and what happens in the case of disability and/or death.”
“It’s up to advisors to help clients think beyond the divorce and what happens in the case of disability and/or death.”
– Karen Stewart
Insurance policies agreed upon to protect support payments may have been poorly drafted, adds Jamal. “We see many separation agreements where the insurance provisions in place become the subject of litigation when death hits.”
An example of this was the Turner Vs. DiDonato case heard in 2009 at the Ontario Court of Appeal. In the original separation agreement, Mr. DiDonato agreed to pay his first-wife support until she reached age 65 and maintained a life insurance policy of $100,000, until he was no longer required to pay support at age 65.
When Mr. DiDonato died at age 58, he only had $43,507 invested in the policy. This was the amount he intended his first-wife to be entitled to. However, because of the way the policy was drafted, the court ruled that the first-wife was entitled to the full $100,000 claim no matter what. His second wife tried to appeal, however, the court ruled in Ms. DiDonato’s favour and as a result, Mrs. Turner was required to pay the remaining amount of $56, 493 claimed against her husband’s estate.
This is a case where the amount of life insurance provided to secure the spousal support payments should have declined with age, adds Jamal. “If the policy provisions in the separation agreement were drafted correctly, the insurance obligation would have declined in line with the declining spousal support obligations.”
When it comes to child support payments, life insurance policies written in the form of a “bare trust” are problematic as well, says Jamal. This means that when a separation agreement is drafted and includes provisions for life insurance proceeds to be held in trust for a child, there are no specific terms as to how or when the proceeds will be paid or maintained.
“In a bare trust, a child cannot access the funds until that child reaches the age of majority, usually 18, unless his or her guardian goes to court before then to authorize the payment,” says Jamal. “However, if the drafters of the agreement had specified that certain amounts needed to be paid to the guardian of the child prior to the age of majority, this could have prevented the delay and the unnecessary cost of accessing funds.”
If one part of the couple owns a business, in the case of death, there’s also the controlling interest of the company to consider, adds Stewart. “The key question here is who inherits the controlling interest of the company and can they run the company?”
This is where a key man life insurance policy could provide relief to clients that are business owners. Upon death their estate will receive a tax-free cash payment that can be used to hire another key person to run the business or pay off-debts that could impact the value of the estate.
In the case of a divorce, the beneficiary of the policy could be the separating spouse, adds Stewart. “This ensures if the client remarries, the former spouse still retains the controlling interest of the company.”
Finally, “estate equalization” insurance strategies could be put in place to level inheritances in a separation agreement, says Asher Tward, vice-president of Estate Planning with Tridelta Financial Partners Inc. in Toronto. “This type of insurance strategy levels the family dynamics between a former relationship and a new relationship the client could enter into.”
It’s also a good tool to ensure that children of multiple marriages are treated with equality. For example, if a client ran a successful business worth $1 million and had already negotiated to leave the value of that business to his or her first partner upon death, he or she could purchase more life insurance policies of that same amount to ensure other family members are treated equally.