How Can You Protect Your Heirs’ Inheritances from Their Creditors?

“The only person who sticks closer to you in adversity than a friend is a creditor.” (Unknown)

You’ve done everything you can to leave your loved ones financially secure after you die. You’ve left enough assets to set them up in their own lives, made a valid will (“Last Will and Testament”), and chosen a trustworthy and efficient executor to wind up your deceased estate. You think you’d done everything you can to help and safeguard them.

But what if you missed something – something that could be a real gamechanger for your heirs?

Insolvency and attack by creditors

We’re talking here about one or more of your heirs getting themselves into serious debt. It really can happen to anyone. As the out-of-the-blue pandemic lockdowns confirmed, even the most prudent of people can find themselves unexpectedly in the dwang. The danger is that if your heirs’ personal estates are sequestrated, or if their creditors execute against their assets, their inheritances could be attached – and lost to your family forever.

Fret not! There are ways to manage this risk whilst still ensuring that your heirs are looked after. Which route is best for you calls for specific legal advice. But here are the main options:

1. Set up a discretionary trust: You set up a trust to which you leave everything, or just a portion of your estate, or specified assets. This ensures that the inheritance is managed by trustees for the benefit of your heirs, and out of reach of their creditors – if you do it correctly.

   Choosing the right form of trust (the most commonly encountered types being living or “inter-vivos” trusts and will or “testamentary” trusts) needs careful consideration with professional guidance. It’s equally critical to use the best structure for the trust, its assets, and its management.

   Tax and other practical aspects also need careful consideration. In the context of protecting assets from creditors, it’s vital to make the trust a “discretionary” one, because the trustees in a discretionary trust can distribute to beneficiaries at a time of their choosing, rather than the inheritances automatically vesting in your heirs (and being attached).

2. Insert an “insolvency clause” into your will: This one calls for particularly careful drafting by a professional. Our courts have previously held that it is not permissible to simply include a clause or condition that’s intended to prevent creditors from pursuing an heir’s inheritance once that heir “has acquired rights to the inheritance.”

   Rather, the clause needs to create a “gift over” such as a provision stating that if your heir is insolvent at the time of your death, the bequest must accrue to another person. Or perhaps you could allow your executors a discretion to divert the inheritance? Clearly, crafting such a clause to both benefit your heirs and withstand attack from a creditor or the trustee of an insolvent estate requires specialist help.

3. Create a usufruct or fideicommissum over assets: If you want to leave an asset (typically, but not always, immovable property) to your heirs, you could create rights for them under a “usufruct” or “fideicommissum” – technical terms which again require specialist advice and consideration of all the legal, practical and tax angles.

The last option, of course, is to leave it to your heirs to repudiate (reject) their inheritances after you die. That’s not a first prize solution as it requires your heirs to both understand the legal position and to repudiate at exactly the right time.

A will is only as good as its most recent review

There are many good reasons to diarise regular reviews of your will: changing circumstances; new laws and taxes, the list goes on… But we’ve just added another reason. While conducting these reviews, consider whether any of your heirs could be at particular risk of financial distress and if so, how you can manage that risk. Let us know if we can assist!

Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.

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