Angus Kerr discusses best practices when passing wealth on to the next generation.
When most people consider what they will pass on to loved ones it is common to focus on belongings such as pieces of art and antiques - physical investments that can also grace your home and be physically gifted to children and grandchildren. If you have a good eye and a long enough holding period, you could stand to make some real money from these sorts of items. Beautiful antiques and artworks can also, in certain cases, feel more tangible than financial investments, which some may see simply as numbers on a computer screen.
But antique buying is a long-term hobby which comes with its own risks and rewards. There is a fundamental difference between an illiquid collectible such as antique furniture, and investments in regulated financial markets, which should aim to yield income over time in addition to offering the possibility of capital gain.
Most of us aspire to pass wealth on to the next generation and one way of doing this is to grow wealth through income-generating investments which can be passed down. However, unless you manage the process carefully you can end up losing a significant proportion to taxation. Though it pays to take professional advice, here are some general issues to consider.
The first is Inheritance Tax, a tax paid by a person who inherits money or property of a person who has died. As a rule, it’s only due if the total value of the deceased’s assets is more than £325,000. That means the first £325,000 is free from IHT but any assets over this value will be subject to IHT at 40%. Savings in a money purchase pension usually do not count in your estate for tax purposes and are therefore currently exempt from IHT. So are any donations to a charity or community amateur sports club.
If you leave your home to your children or grandchildren your threshold can increase by £175,000. This is known as the main residence nil-rate band. If you are married or in a civil partnership and your estate is worth less than your threshold, any unused threshold can be added to your partner’s threshold when you die. This means the surviving partner’s threshold can be as much as £1 million.
However, for every £2 your estate is valued at over £2 million you lose £1 of your main residence nil-rate band. That IHT taper means couples with an estate valued at between £2 million and £2.7 million will see their residence nil-rate band gradually eroded to nothing.
The impact of that taper is significant.
HMRC receives over £5 billion a year from IHT, and this figure is likely to increase. The Chancellor has a budget deficit of £280 billion this year. In the March Budget he froze many allowances as he began looking for ways to repair public finances. It is inevitable that more families will find themselves caught by IHT and inflation alone will be sufficient to tip many households into the IHT trap.
Pensions were also caught in the allowances freeze. The standard Lifetime Allowance, the amount you can accumulate in pension savings over your lifetime without incurring tax charges, was frozen at £1,073,100. A pension of £1 million, for example, might grow 5% a year and be worth £1,276,000 in five years’ time, therefore going beyond the threshold. That pension will then be subject to a 25% charge on any money withdrawn as income – on top of income tax – or 55% on any lump sum. However, that pension can be left to loved ones and is a great way to help children and grandchildren with their own savings plans. It may be worth considering giving away surplus money ahead of retirement.
Under Potentially Exempt Transfer (PET) rules, you can pass on property, assets and possessions free of IHT as long as you do not die within seven years. You can give away £3,000 worth of gifts each tax year without triggering the PET clock and wedding or civil ceremony gifts of up to £1,000 a year per person, £2,500 for a grandchild or £5,000 for a child. You can also give payments to help with another person’s living cost and can also support a child’s higher education cost. Finally, you can give away the family home but to carry on living in it you will need to pay the new owner the market-rate rent and continue paying the bills. We certainly would not recommend this without advice.
One of the best ways to give is out of your income. This is particularly attractive for those with high final salary pensions. You must show that you can maintain your standard of living after making the gift and can give as much as you can afford through this mechanism without triggering the PET clock. One attraction of this is that it allows you to give gradually over time and mitigates the need to make a big decision on gifting too early.
One final thing to consider is that if you leave 10% of your net estate to charity your IHT rate will fall from 40% to 36%. So, if you have a large estate and are planning to leave between 4% and 10% to charity anyway, your beneficiaries will be better off if you lift your gifts to the 10% mark. I must stress again that IHT planning is complicated and that it is worth taking professional advice if you are concerned about this issue.
A good adviser can help you devise a sound gifting plan. They can help you make best use of tax-efficient savings tools, like ISAs and pensions, as you are accruing wealth. They can advise on taking money from the right pots in the right order in retirement. At Rathbones we can help you manage any significant gifts you make to children and grandchildren, to ensure the money is invested appropriately and wisely until they need it.
You may not be able to avoid paying IHT, but with careful planning you can reduce the bill so that loved ones receive as much of your estate as possible.
*As at 30 June 2021, includes funds managed by Rathbone Unit Trust Management Limited
For media enquiries and more information, please contact Holly Deegan: holly.deegan@rathbones.com or 07341 045 997.