The coronavirus pandemic and lockdown has been a strange and difficult time for all of us, not to mention also extremely sad for some people with life-changing events becoming common place. The crisis has meant that we have all come face to face with our own mortality and the isolation of lockdown has offered a time for reflection. This has undoubtedly concentrated the minds of many parents and grandparents to think about how wealth should be passed down to the next generation.
Many people have had estate planning strategies in place for some time but the unprecedented effects of the pandemic have meant that priorities and financial situations have changed and people are now reassessing their plans.
Younger generations undoubtedly will be hit hardest by the enormous financial cost of the crisis and will become ever more reliant on the “Bank of Mum and Dad” for financial support. Equally, older generations will need to evaluate how any cash calls could impact their own retirement plans in the wake of recent stock market volatility.
More and more families are being forced to reconsider their estate planning strategy as fears grow over future tax rises, particularly taxes on inherited wealth, to cover the cost of the pandemic. A UK wealth tax and a reform of Inheritance Tax is now more likely than ever due to the reordering of politics caused by the coronavirus pandemic. Covid-19 has created a clear, burning platform for tax reform according to Lord O’Donnell, a former head of the civil service.
With an estimated £3.2 trillion of intergenerational wealth transfers due in the UK and USA over the next 20 years, people who had not previously considered gifting assets are now exploring the most tax efficient ways of passing their wealth on to the next generation and beyond, before any rule changes take place.
Even before the Covid-19 crisis, it was widely thought that the Budget in November 2019 would introduce a gift tax to replace inheritance tax. The possibility of this type of radical change now seems even more likely to help pay for the enormous cost of the Government economic support packages.
Under current inheritance tax rules, unlimited sums can be given away under the “seven-year rule” without any immediate tax liability. The value of the gift falls out of the taxable estate completely after 7 years and no IHT is payable. There is also tapering relief after the first three years.
However, as alluded to in our recent article Is this the death of inheritance tax as we know it?, there is a real possibility that IHT could be reformed and the seven-year gift rule could be abolished and replaced by an immediate tax on gifts above a certain level.
Families should look at ways of passing down assets as well as cash and now could be a good time to have a detailed review of your portfolio and identify which assets can be handed on. Although assets can be passed between spouses without triggering a Capital Gains Tax bill, this is not the case for gifts to children and/or grandchildren. However, couples can manage the transfer so that they both make full use of the annual capital gains tax exemption, currently £12,300 per person.
Where there is CGT to pay, the rate of tax for many clients is relatively low at 20% for non-property assets but many financial commentators think this rate could be increased in a future Budget. This is another reason to act sooner rather than later.
A further benefit of making transfers now is that even if the asset subsequently rises in value, any potential IHT liability is based on the value at the time of the gift.
One of the easiest ways to help children or other family members is by making use of the regular gifts exemption. This is particularly efficient from an inheritance tax point of view as IHT is not charged on gifts made from an individual’s “surplus” income; loosely defined as income not otherwise required to maintain your usual standard of living.
This is a very useful exemption which is often used to pay the premiums on relevant life cover. This can act as a form of wealth creation for younger generations as the sum assured is usually many times the actual cost of the premiums. On death the amount paid will be free from IHT if the policy has been drawn up correctly. Specialist advice from Clarion is essential.
Under current IHT rules it is possible for individuals to give away assets or cash up to a total of £3,000 each tax year, without it being added to the value of the estate for IHT purposes on death. Unlimited gifts of up to £250 are also allowed to as many people as you like and parents can gift up to £5,000 to their children on marriage. For Grandparents the amount is £2,500.
Gifts worth more than £3,000 may become liable to IHT on death within seven years. These gifts are called potentially exempt transfers (PETs) because on death within seven years there will be tax to pay on a sliding scale depending on how long the person lives after making the gift.
Another way to pass money down to younger generations is through a trust. A limited amount of cash, at the most £325,000 or £650,000 per couple, can be put into a trust without triggering any immediate inheritance tax charge. Trusts are useful where the financial needs of the beneficiaries are not yet clear. In effect this creates a type of “emergency fund” that different children or grandchildren can benefit from, if and when needed.
However, it is possible that the future taxation of trusts is something that could be reformed and made less attractive, providing another reason for early action. Once again specialist advice from Clarion is essential.
As an alternative to a family trust, people with large estates could consider setting up a family investment company. This is a limited company which can be used to hold a broad range of assets including property, cash and investments. This approach allows the family to control assets while accumulating income in a tax efficient manner. It also helps with family succession planning and provides an effective tool for wealth planning.
Family investment companies can have different share classes so that, for example, the parents are the trustees and make decisions on the assets and the children are the beneficiaries. Generally, no tax is charged on the income provided it is reinvested, although there could be personal income tax charges to consider when extracting funds.
Making gifts or settling assets into trust usually takes seven years to become completely free from inheritance tax but an investment in a BPR qualifying company can be passed down to beneficiaries free from inheritance tax on the death of the shareholder after 2 years.
Owing BPR qualifying shares also allows a client’s wealth to stay in their own name. BPR qualifying investments do not use the nil rate band. Which means investors can plan for their nil rate band allowance to reduce the inheritance tax charge on less liquid assets such as the family home.
It is also possible to utilise the favourable business property relief IHT treatment for ISA investments.
Investment in a BPR qualifying scheme is a really effective way of passing assets to the next generation with full inheritance tax relief after only 2 years but as this is an area that looks ripe for reform, early action looks to be a sensible approach.
There are a number of BPR schemes on the market and specialist advice regarding this complicated area is essential.
Despite compelling arguments for passing on wealth, some parents who would like to pass on assets may now feel more constrained than previously due to the recent stock market volatility caused by the coronavirus pandemic. For example, the value of their pension funds may have been hit by market volatility and/or income could have been reduced by the sharp drop in dividend yields. This could impact their ability to provide for children and/or grandchildren.
The market downturn has meant that parents are reassessing what they need for themselves. One of the first rules of intergenerational gifting is that you should only give away what you can afford to live without forever.
One positive thing to come out of the pandemic crisis is that people’s minds have become focused on the importance of family, the value of personal relationships and the desire to take care of each other.
Families spending more time together has created a better backdrop for some of life’s more fundamental questions to be discussed. People have been forced to face the stark reality of their own potential mortality. Thoughts and discussions that may have been previously delayed regarding intergenerational wealth transfer are now much more likely to be tackled.
The coronavirus crisis has focused minds on intergenerational gifting, will planning, trusts and reassessing existing estate planning strategies. The state has a huge need for new sources of revenue in view of the colossal cost of support measures to keep the economy afloat during the coronavirus pandemic crisis and it seems very likely that inheritance tax will be a target for reform. This could see the introduction of a Gift Tax applied at the time of the gift, so early action might be advisable for people thinking of passing down wealth.
Specialist advice is vital and the lifetime cash flow planning strategies used by Clarion can help to provide a valuable guide as to how much can be given away without affecting the income and capital security of the parent and/or grandparent.
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