Meeting a great grandparent is becoming the norm for today’s children. As we live longer it is quite typical for four generations to be alive and well in any one family.
This is something to celebrate but it does require individuals to rethink how they plan for the future.
Financial planning needs to be done on an intergenerational rather than individual basis. Instead of considering bequeathing assets to children alone, it is worth considering how grandchildren and great grandchildren can benefit.
Inheritance Tax (IHT) is hefty – 40% of the total qualifying estate – but there are ways to limit the bill. Financial planners need to think about the services they provide to the family as a whole. Rather than focusing on the wealthiest generation in isolation, there will be opportunities to help all members of the family who will experience different financial challenges simultaneously.
The baby boomers are usually considered the wealthiest of today’s surviving family members. They are some of the last to enjoy the benefits of a final salary pension, while also likely owning one, or maybe multiple, houses. Meanwhile, younger generations (z, x and the millennials) struggle with student debt, rising house prices, an evolving job market and an uncertain economic future.
Fortunate though the baby boomers are in terms of accruing wealth and assets, they are among the first to experience long retirement. Today’s retirees need adequate funds to cover daily expenses for many years, as well as pay for long term care while leaving some for the next generations.
This generation will have retired before the advent of freedom and choice which allows those with a defined contribution plan to draw their pension with impunity after age 55. In such cases, they will likely be enjoying a secure income from their final salary plan, but what of their other assets?
Consideration needs to be given to how much income is required in retirement and how long this income needs to last. This is a difficult question for advisers but with an idea of inflation expectations, lifestyle and health, some indication can be achieved. Next, is to establish whether they can reach that income target based on an assessment of assets.
Where there are surplus assets, now is the time to assess IHT planning. There are several tax efficient ways to pass assets to descendants, but these have different constraints and obligations.
The easiest route may be to pass cash to family members. However, aside from the use of small and annual gift allowances, larger gifts will typically take seven years to fully fall outside of the taxable estate. It also means those doing the giving lose total control of the money.
A more complex option, but with greater restraints on the recipients, is to set up a trust which is exempt from IHT. However, as with gifting, once the assets are in the trust the individual loses control.
An alternative tax efficient option is investing in shares that qualify for Business Relief (BR) and holding them for more than two years.
To qualify for BR the shares cannot be listed on a public stock exchange such as the FTSE 100. Instead they must be in an AIM listed company or private company that trades rather than invests. BR qualifying shares receive up to a 100% IHT exemption, depending on the stock, and the individual retains control. BR can be held directly or form part of an ISA giving them added flexibility. However, these are investments and are not without risk.
Irrespective of whether gifts, trusts or BR are used, advice is of paramount importance to avoid costly mistakes.
Home is where the heart is
How people deal with the family home is also an area where advisers can add significant value. Passing the family home to the next generation is an enormous emotional (as well as financial) move, and ensuring this is done in the most effective way for all concerned is important.
Here advisers should make best use of the residence nil rate band (RNRB).
The nil rate band has been stuck at £325,000 for some time, meaning anyone with an estate exceeding that figure starts paying IHT. Clearly this is an issue given today’s escalating house prices. In response, the government introduced the RNRB from April 2017 which allows home owners an additional £100,000 before they are subject to IHT. This will increase each year by £25,000 until 2020. Prior to 2017, a husband and wife or civil partnership with an estate of £900,000 would have been subject to an IHT liability of £100,000 on second death. Thanks to RNRB, by April 2018 that bill falls to zero – provided the couple qualify for the RNRB.
Only direct descendants qualify for RNRB. Married couples leaving their assets to each other may transfer the RNRB to the surviving spouse allowing them to use up to twice the tax-free amounts available to a single individual.
It is worth mentioning the use of will trusts at this point. There are some real positives to putting in place a discretionary will trust, however care needs to be taken as such trusts can impact upon the availability of the RNRB. Trusts may also help keep the value of the estate below the RNRB £2 million threshold. Essentially, careful consideration is needed to ensure the best use is made of RNRB where appropriate. And despite the RNRB, IHT will continue to be an issue for many individuals.
Flexible pensions are another tax efficient way of passing money down through the generations. If the pension scheme member dies before age 75, their nominated beneficiaries will not have to pay any tax on withdrawals, whether as an income or lump sum. If the pension member dies after age 75 pension assets become taxable, but only at the marginal rate of income tax of the recipient.
Meanwhile ISA holdings still form part of the taxable estate for IHT purposes. A surviving spouse or civil partner can inherit ISA funds from their deceased partner or make an additional ISA subscription up to the value of their deceased partner’s ISA holdings. It is possible to invest ISA funds in AIM listed companies that can qualify for 100% IHT relief after two years of ownership.
We all know the saying ‘you can’t take it with you’ but the pot still needs to last until the end. Intergenerational planning is about striking a balance between providing for each of the individuals with the right tax efficient income to cover different needs on various stages of their life. The right advice at the optimum time is crucial in ensuring each generation can share in the family’s wealth both today and in the future.
Ten top tips for effective intergenerational financial planning
1. Start inheritance planning early to avoid time restrictions
2. Consider the wider family when dealing with individual clients
3. Understand financial planning strategies that can benefit several generations simultaneously
4. Be the trusted, expert adviser on intergenerational IHT issues
5. Think about including Business Relief as part of IHT planning
6. Use the RNRB to full effect
7. Revisit trusts to assess their efficacy for today’s families
8. Use pensions as an efficient means of protecting the legacy
9. Ensure clients do not pass on too much too soon and lose control or become dependent
10. Review everyone’s circumstances regularly
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This article was originally published in Investment Life & Pensions Moneyfacts January 2018 (Issue 255)