If you are the inheriting spouse, we’ve got some bad news: your inheritance is not in a protected class of assets that will be automatically quarantined from the property pool when you separate.
So, what can you do to protect your inheritance?
If you are still with your spouse
The best protection is to sign a financial agreement.
Financial agreements are sometimes referred to as ‘prenups’ (the American terminology) but in Australia they can be made before or during a de facto relationship or marriage.
A financial agreement can be drafted to quarantine an inheritance only, so that all other assets built up during a relationship are not subject to the agreement.
While no lawyer can provide a cast iron guarantee that a financial agreement will not be set aside in the future (read our article on this topic here), financial agreements are the most the law can offer a spouse wanting to protect their inheritance.
If you have separated
The Federal Circuit and Family Court of Australia has a wide discretion about how to treat inheritances. The court can do either of the following:
- Quarantine the inheritance
The spouse who received the inheritance will retain it, and the other assets of the parties would then be divided in accordance with the parties’ contributions and their future needs.
- Include the inheritance in the pool to be divided between the spouses
The court will consider the inheritance a contribution made by the spouse who received it, except in unusual circumstances, but will not reimburse that spouse dollar for dollar the amount of the inheritance. The inheriting spouse may simply receive a larger percentage of the pool to reflect their contribution of the inheritance.
It is important to remember that the property pool does not crystallise at separation and the court can adopt either approach, even if the inheritance is received after separation.
The first approach is generally only adopted where an inheritance is received shortly before or after separation.
Where an inheritance is received in the first few years of a lengthy relationship, the second approach is more likely to be used because the inheritance is seen to be eroded by contributions made by the other spouse over the course of many years.
While the Full Court of the Federal Circuit and Family Court of Australia has said that either approach may be taken, it will be more readily arguable that the first approach should be applied if you can ‘self-quarantine’ your inheritance. By this we mean, for example:
- if you inherit cash, deposit the money into a sole bank account in your name (with no other funds being deposited into this account) and keep it entirely separate from your other assets
- if you inherit a house, make sure your spouse makes no contribution to the property by way of, for instance, paying the mortgage repayments or undertaking renovations on the property.
It is much easier for a spouse to argue there ought to be one property pool where they can show an inheritance has been intermingled with other assets built up during a relationship or they have contributed towards inherited property.
How to avoid the inheritance argument all together
Finalise your property settlement in a legally binding way (that is, consent orders or a financial agreement) as soon as possible after you separate. In cases where an inheritance is received post-separation and then included in the property pool divided between spouses, the spouse that received the inheritance certainly gets credit for their contribution, but, had they finalised their financial matters earlier, they may have been able to keep it all to themselves.
If family members you expect to inherit from are still alive, it may be that their good estate planning can avoid the inheritance argument all together, through the use of a testamentary trust. Of course, it will be a matter for those family members to obtain their own quality estate planning advice with asset protection from spouses of their beneficiaries in mind.