By passing money on before you die, you can enjoy the good it does and know that it has been handed on in a tax-efficient way.
Passing wealth down the generations while you are still around to see the impact it has can be very satisfying – and incredibly tax-efficient. But before parting with your cash, it’s sensible to weigh up the pros, cons and practicalities.
Living inheritances have certainly become much more popular, according to Tony Mudd, divisional director, tax and technical support, at St James’s Place. He says: “When I joined the company in the 1990s, most estate planning occurred at the point of death. But over the past five to 10 years, the situation has changed dramatically, with parents and grandparents looking to pass on their wealth earlier.”
This observation is supported by research conducted by Royal London, which has found that current grandparents have passed on around £50 billion to their children, while grandchildren have received around £38 billion from their grandparents and parents.
It’s good to give
From a family wealth perspective, giving while you are living makes sense. Rising property prices over the past decade have resulted in babyboomers owning a healthy chunk of the UK’s property wealth. Meanwhile, the price inflation that enriched baby-boomers is preventing millennials from getting on the property ladder.
Passing wealth down the generations via living inheritances is equitable, but it can also be highly rewarding for benefactors, who can enjoy seeing someone benefit from their wealth.
Simon Stanney, equity release director at SunLife, says: “It’s fantastic knowing that a child or grandchild is using money you have given them to help themselves through university or to put towards their first home – you can see where your money has gone. And saving them from paying rent or racking up debt can be worth much more to you than the money you give them.”
Moreover, a living inheritance can be more tax-efficient than a legacy distributed through a will. On death, once the nil-rate band (£325,000 plus a further £150,000 in 2019/20 if an estate qualifies for the residence nil-rate band) is used up, HMRC will want 40% of any surplus.
In addition, flexibility about who receives money can accrue valuable inheritance tax (IHT) planning benefits. For example, grandparents may choose to bypass their children – for whom a large financial gift might simply trigger an IHT nightmare – and give their money to their grandchildren instead.
Handing over a significant amount of cash isn’t always straightforward, though. “You need to consider whether you can and should give away money,” says Mudd. “Is the recipient financially responsible? Is there a risk that money could disappear in a divorce settlement or be swallowed up if a recipient is declared bankrupt? ”
There’s also the simple matter of whether you can afford to give your money away while you are still living. Your finances might be in good order, but unexpected costs such as property maintenance can cause a financial shock, while longer life expectancy is increasing the risk of people needing nursing care.
“Lots of clients struggle to find a balance between what they give away and what they keep,” says Svenja Keller, partner and head of wealth planning at Killik & Co.
She uses cash flow modelling to help people see what, if anything, is surplus. This factors in an individual’s likely life span and future costs, including possible long-term care costs. People often underestimate how long they are likely to live, says Keller.
“The average life expectancy is now 80-plus. But you may live well beyond this, particularly if you’re wealthy,” she adds. “Another 10 years of expenditure is a lot of money.”
There’s also the risk that you give away large amounts of money and then need nursing care to ponder. When assessing your finances, a local authority might decide that you have given money away intentionally to avoid paying care fees. If they suspect this practice – known as a deprivation of assets – they will treat you as if you had not given the money away.
A living inheritance might help your family sidestep a 40% IHT charge when you die, but being alive when you give money away doesn’t guarantee that your family won’t be hit with an IHT charge. Seven years must elapse before a gift is deemed to be outside your estate for IHT purposes.
Taper relief that can reduce the tax payable from year four onwards is available, but it comes with a sting in the tail. Keller explains: “Gifts come off the deceased’s nil-rate band first, so unless they have given away more than £325,000, their estate won’t benefit from the taper.”
Gifting at a point where you expect to live for more than seven years is the preferable way to avoid IHT, but you can also take advantage of exemptions to make your living inheritance more tax-efficient.
Make good use of tax exemptions
There are various ways to give cash away without incurring any potential IHT liability.
• You can give away £3,000 a year (and a further £3,000 if you haven’t used the exemption in the previous tax year).
• You can give as many gifts worth up to £250 per person as you like.
• Wedding gifts are tax-efficient. Parents can gift up to £5,000 and grandparents £2,500.
• You can gift regular sums from surplus taxed income.
In all cases, says Ed Monk, associate director at Fidelity International, it’s essential to keep careful records of your giving. “Document everything,” he adds. “These exemptions are only tested on death, and without records, you risk leaving your executors with a real headache.”
Retain some control
Where the desire to give is muted by concern over how money may be spent, it’s possible to retain some control. Trusts are an option worth considering. Mudd says trusts are really just gifts with strings. “A discretionary trust can have a whole host of beneficiaries,” he adds. “If you make yourself a trustee, you can decide exactly who gets what and when.”
It still takes seven years for money put into a trust to leave your estate, but a trust is useful if you are worried about how a child might spend money or that a direct gift might disappear in a divorce settlement. It’s sensible to keep the trust value below £325,000, as this avoids tax charges.
Another way to keep some control is to give for a specific purpose, such as to fund university fees or a house purchase. This can reduce the possibility that money simply gets frittered away.
Help with a deposit on a property is becoming crucial for young buyers, with the average first-time buyer needing to deposit an eye-watering £32,841 according to Halifax. David Hollingworth, associate director of communications at L&C Mortgages, says: “Lenders are fine with [financial help towards a deposit], but they may seek confirmation that it’s a gift and not a loan.”
Financial product gifts
A gift into a pension scheme is another option unlikely to create temptation, at least until the recipient reaches age 55. With such a gift, the joys of compound interest will take some pressure off them when they are older.
Keller says: “A child would have to pay £3,600 into a pension every year between age 45 and 55 to come close to the value at age 60 of a single £3,600 contribution at birth. [Compounding] is very powerful.”
Another way to help without simply handing over cash is to pay for financial products such as life insurance, critical illness insurance and income protection that can benefit the giver and the beneficiary. Mudd explains: “It saves the [beneficiary] some money every month that they could spend on something else while making it less likely that they will come to you for financial support if they become seriously ill or unable to work.”
Documented correctly, the premium could take advantage of an IHT exemption, such as the £3,000 annual exemption or the gifts from surplus taxed income exemption.
Whether you are comfortable handing over a large lump sum to a beneficiary or would prefer to tie it up until a beneficiary reaches retirement or beyond, it is essential to understand the financial and emotional implications of a living inheritance. Done correctly, such an inheritance can benefit those giving as well as those receiving.
Art in asking for a living inheritance
If you are looking to encourage some wealth to trickle down to you, it’s worth thinking carefully about your strategy.
“Your parents and grandparents may well be happy to help, but unless you are clear about what you need and why you need it, you might wait a long time,” says Becky O’Connor, a personal finance specialist at Royal London.
She adds that the following tips may make asking a little easier.
• Go in gently. They are under no obligation to give you money, so show them that you are aware of the financial sacrifice they would be making.
• Help yourself first. If you are already saving, they will be reassured that they are not just funding your social life.
• Do some homework. If you are after money towards a mortgage deposit, do some research on costs, mortgages and schemes such as Help to Buy.
• Point out the tax breaks. This will show that you have thought about your proposal carefully, which may help convince them to gift you money sooner.
While these tips are useful for younger generations, they can also be helpful in shaping the expectations of older generations looking to give some money away to younger family members.