Intergenerational finance – how to ‘give with warm hands’

Many of us want to leave a legacy to our families after we have gone, but our desire to help our families is balanced by our need to ensure we have enough to live on in retirement. There is a difficult line to tread between building up assets that end up being eroded through inheritance tax and depriving ourselves of the money we need.

Careful planning and family discussions about inheritance can help to make the process less fraught and ensure that as much money as possible is passed down to family, rather than given into the hands of the taxman.

Changes to the Lifetime Tax Allowance, announced in the recent Budget, make doing this even easier.

Here is how to go about making a plan.

Understand the tax burden

Inheritance tax is levied on any portion of your estate worth over £325,000 when you die. As it is a 40 per cent tax, this can be a substantial sum and seriously cut the amount your children or grandchildren will inherit.

Anything that remains in your estate when you die will be taxed, but also assets that you have given away less than seven years beforehand. This is obviously to prevent people giving away everything on their deathbeds to minimise tax, but it does incentivise many of us to start giving away at least some of our money when we retire. This is often known as ‘giving with warm hands’ – ensuring that money trickles down the generations while we are still alive.

Use and understand allowances

But as well as giving money away early, there are extra allowances that can take down your inheritance tax burden. Using each of them will help. They include:

  • Planning to pass your main residence to a spouse or direct descendant

If you die before your civil partner or spouse, passing the house to them will not incur inheritance tax. If you leave it to your children or grandchildren, your inheritance tax threshold increases to £500,000. You can also inherit your spouse’s IHT exempt allowance, meaning that a couple can pass down an estate worth a million pounds without paying any IHT. If the estate is worth over £2m, though, the allowance decreases so your family will end up paying more tax.

  • Using your annual gifting allowance

Everyone can give away £3000 in gifts tax free each year, and it won’t count as part of your estate, even if you were to die soon afterwards. Making sure you make these gifts can reduce tax liability over time. You can carry forward this allowance for one tax year, so if you didn’t make gifts in the April 2022-23 tax year, you can make £6,000 worth this year. There are extra allowances if a family member gets married.

  • Giving gifts out of income

If you still have a regular income, from a pension or job, you can start giving away regular amounts of this income and it will not count for inheritance tax purposes. The key here is that the gifts must not leave you with little enough income to affect your lifestyle. You will have to record the regularity of these gifts, so it makes sense to contact a financial adviser about this.

Investigate investments

There are some types of investment that can help to reduce your liability to inheritance tax. However, they are only for sophisticated investors as they tend to focus on early-stage companies, and it is really important you see an adviser if you think these may be for you.

Investments and schemes include

  • AIM stocks

Some stocks traded on the Alternative Investment Market (AIM) are eligible for Business Relief, which provides up to 100 per cent relief from inheritance tax. These stocks can now be held in an ISA, making this an even more attractive investment proposition. However, AIM is a market with early-stage companies in it, and there are risks with all investments that you might lose money, but particularly with those at an early stage.

  • Enterprise Investment Schemes (EIS)

If you invest in an EIS, you not only get 30 per cent tax relief on the investment if you hold it for three years, but you also receive the same inheritance tax relief as AIM shares if held for two years. These are also risky early stage investments, so advice should be sought.

  • Life insurance in trust

If you have a life insurance policy, you can have it written ‘in trust’ so that the proceeds go to your descendants outside of your estate, rather than it becoming part of it for inheritance tax purposes. Again, speak to an adviser – existing policies can be written in trust, or you can take out new ones, but it is important that it is done in accordance with certain rules.

See your pension differently

As well as these schemes, there is already an asset that most of us have that could be used as a very valuable vehicle in passing money down to your children or grandchildren. This is your pension, which sits outside your estate for inheritance tax purposes, and can be passed on down the generations in a very tax-efficient manner.

The government’s lifting of the Lifetime Allowance for pensions – meaning that you can save even more into these vehicles that before, - has potentially positive consequences for the pension as an inheritance vehicle for even more of a family’s assets, though there is still more detail to be seen on this.

If you die before the age of 75, your dependants can inherit your pension and take the money out tax free, and if not it is taxed at their highest tax rate.

These benefits mean it may be sensible to keep as much money in your pension as possible and spend other sources of income in retirement first, but a financial adviser will be able to help with a bespoke decumulation strategy.

Put plans in place

Once you have decided on a strategy to ensure you can pass money down to your family, you need to make sure all of it is implemented correctly. Steps to take include:

  • Nominating a beneficiary for your pension with your pension company, as your will won’t do that for you.
  • Ensuring your will is up to date and you have told relatives where it is.
  • Updating or putting in place a financial power of attorney so that someone else can run your affairs if you become ill.
  • Talking to your family about your plans.

2 May 2023