Those who have created their own wealth may find it daunting to pass it on to those who haven't put in the work, as Tim Walford-Fitzgerald explains.
The question of passing wealth down through the generations has always been important but as younger people face challenges getting on the property ladder, which has led to the moniker, "generation rent", many want to support their children and grandchildren more than ever. But the older generations are also much more cautious; society itself is very different and the impact of changing relationship arrangements and break ups cannot be underestimated.
Everyone tends to worry about future and later generations, those who have simply seen the reward of the hard labour and not experienced the same journey to get there. It is typically those families who are concerned over allowing wealth to transition down generations during their lifetime.
Intergenerational planning works best with a longer-term strategy and measures being taken over time."
Who?
When deciding who to transfer to, it is vital to consider whether the individual receiving the benefit is financially educated. Have they formed their own plan to manage assets or will they struggle to adjust to their newly acquired wealth? Certain clients we speak to want the best of both worlds - to gift assets to the next generation while retaining control while they are still alive. There is no single panacea that solves all situations, each instance needs careful consideration and sensible planning involving the entire family.
Intergenerational planning works best with a longer-term strategy and measures being taken over time. When the rules are changed suddenly in a Budget announcement those plans can be upset very easily. This could be a change to the tax treatment of a particular step, such as a disposal of particular assets, or changes to the way parts of the structure are taxed, such as trust taxation or the taxation of non-domiciled taxpayers.
Education and compromise are important. Making later generations aware that their comfortable lifestyle is only possible with respect for the value of money and that they have a duty to ensure the same comfort for their descendants goes some way to preventing the wealth being squandered. Separating the pot out to allow family members to go their own ways leads to a number of smaller investments, without the oversight and centralised strategy that could protect the value and, hopefully, keep it growing.
We recommend considering the below criteria before deciding who to transfer your wealth to:
- Review- understanding the income and assets available to give away is the crucial first step. Future potential needs such as personal care costs should not be underestimated.
- Advice- there are many misconceptions and myths surrounding what can and cannot be done so expert professional advice is vital
- Protection- consider where there are risks for the next generation in having assets. Divorce, addiction and poor decisions can have a greater impact than the Treasury.
- Generation skipping- if the second generation is still growing the pot then consider providing for the grandchildren and beyond. Trusts can easily last 125 years and are more about preventing the pot from being blown than protecting it from the Chancellor.
- Education- wealth rarely comes easily. Nurturing a work ethic in the next generation and instilling sense of responsibility to future generations goes a long way to countering the risk of "entitlement".
It is important to remember that you are dealing with individuals. Children have different personalities from their parents and perspectives and circumstances change over time. Continued discussion is important.
How?
In order to plan effectively, it is important to make decisions sooner rather than later. Effective Inheritance Tax planning often makes use of the famous "Seven year rule". Gifts made in the seven years before someone's death are included when calculating the IHT payable. Gifts made more than seven years prior to death are ignored, so planning early increases the chances of surviving for that crucial period.
An often overlooked fact is that there is no Inheritance liability on gifts made regularly out of surplus income, without limit. If the family are lucky to enjoy significant surpluses each year above their outgoings, then gifts can be made freely without concern for the £3,000 annual limit, the £325,000 Nil Rate Band or the seven year survivorship requirement. As this position depends on income being available, it is likely that this will be somewhat earlier that many people start to consider the tax impact of their own mortality.
Other ways wealth is frequently transferred are:
- Trusts, where some control can be retained and influence can persist even after death, and
- Loans, interest free loans, can provide seed capital to the next generation to allow them to grow their own businesses. Loans can be made personally or come from trusts, depending on whether the older generation is willing to forego future access to the money.
One popular approach to Inheritance Tax planning for those with assets likely to grow but not enough to be comfortable making large gifts, is to take steps to ensure that the problem doesn't continue. There are mechanisms that can be used to retain assets and wealth personally- to fund known or expected living costs- but allowing any growth to pass to the future generations.
One example of this is family investment companies. These combine the continued control seen with a trust arrangement with the continued access to value for the older generation. Freezer shares allow the parents to draw income and value out of the company up to a limit, whilst the next generation enjoy the growth above that value. They allow more value than the Nil Rate Band to be passed down and income can either be paid out or retained, after Corporation Tax at 19% (and just 17% from April 2020), depending on individual needs. However, if all the income is to be distributed, a company may be more expensive in tax terms as there can be two layers of taxes- corporation tax as the value is added and income tax on the shareholders as the dividends are taken to extract that value from the company.
Why?
All individuals have their own approach to wealth. Some clients feel that their offspring should be grateful for whatever they get and are unwilling to alter their own positions to allow more wealth to pass down. Others are very conscious of the burden of taxes and wish to mitigate as far as possible, sometimes not considering their own futures in the process.
Another area to consider is the property market, its relative buoyance and the IHT threshold not having increased for many years have dragged many families into the IHT net, without the disposable assets available to the very wealthy that facilitate easier planning. With an illiquid asset such as the main home it is difficult to give away much value but some clients like to explore options such as equity release. However the calculations need to be considered carefully to see what the overall effect will be in terms of the value passing down.
When?
It is easy to make gifts when you have more than you need. Where liquidity is limited or it is preferred to retain more control, such as passing down interests in a family business, more thought needs to go into the planning.
There is a temptation to reserve some sort of benefit from the assets given away. This is rule that prevents people giving away their home, whilst continuing to live in it without paying a market rent.
Another issue is the rule about gifts to benefit your minor children. Whilst under 18, even outright gifts can result in the donor remaining taxable on the income generated. This can be a problem where the parents are looking to mitigate the cost of private education.
This process can never be started too early. The recent Labour Party- commissioned Report "Land for the Many" proposes changes that would materially impact on giving away assets.
Final considerations
Intergenerational planning works best with a longer-term strategy and measures being taken over time. When the rules are changed suddenly in a Budget announcement those plans can be upset very easily. This could be a change to the tax treatment of a particular step, such as a disposal of particular assets, or changes to the way parts of the structure are taxed, such as trust taxation or the taxation of non-domiciled taxpayers.
Whilst significant changes focus the mind, the best planning is undertaken after careful consideration rather than being forced through at the last minute. Given sufficient time matters can often be re-arranged to all parties' advantage. Failing to prepare can lead to a reliance on the artificial schemes that have been marketed and have too often failed to deliver.
Once you have established what you need, there are two ways to transfer the rest: transferring assets to beneficiaries directly or via a vehicle that offers asset protection like trusts and certain corporate structures. Working together on a plan for the future can help buy the next generation in, securing your assets for the long term.
Those making the decisions need to walk a fine line to strike a balance between planning for inheritance tax but also preserving the family wealth. It is a difficult conundrum, but one that can be solved by involving younger generations early on in decision-making, careful structuring but with in-built flexibility. Understanding the next generations attitude towards wealth and ensuring they have a good understanding of how to protect it available can help keep your assets safe.
Tim Walford-Fitzgerald is a private client partner at HW Fisher, a top 25 accountancy firm.
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