A Guide to Intergenerational Tax Planning (2020/2021)
In this guide, we look at:
- Passing on wealth to the next generation
- The benefits of gifting during your lifetime
- How to give away assets tax-efficiently
- Intergenerational tax planning for business owners
- Making gifts without giving up full control
When you have worked hard to build your wealth, it is only natural to want to pass as much as possible on to your family. But it can be a difficult topic to approach, particularly when your children are already financially independent, possibly with families of their own.
A good financial plan will help you look at the options in a positive way, allowing you to balance your own needs with providing a legacy.
Starting to plan now can help to ensure that more of your money ends up in the hands of your loved ones when they need it most.
How much money can be legally given to a family member as a gift?
Making a gift of cash is one of the simplest ways to pass on wealth, but there are a few points to be aware of:
- You can give away up to £3,000 per tax year, which is immediately considered outside your estate
- This can be carried forward by up to one tax year (i.e. £6,000 in the first year)
- A couple who have made no previous gifts could give away up to £12,000 within this exemption
- Regular gifts from surplus income are also immediately exempt
- Smaller gifts for Christmas, birthdays or weddings are also usually exempt up to certain limits
- Larger gifts remain in your estate for seven years. Inheritance Tax (IHT) may apply if you die within this period
- If the gift is over the value of the nil rate band (currently £325,000), any IHT liability will benefit from taper relief if you die from year three onwards
- Never give away more than you can afford. A cash flow model can guide you in making regular gifts while maintaining your own lifestyle
- Make sure you have an easily accessible cash reserve. This can cover any urgent bills or ad hoc expenses, as well as ensuring that you don’t need to make any unplanned withdrawals from your investments.
In some situations, it might make sense to gift assets rather than cash. The rules and exemptions above also apply to other types of gifts. However, the various assets have different tax treatments and caveats to be aware of.
Do I pay UK taxes on gifted shares?
Funds and Shares
You can make gifts of funds or shares. This can be a little more complicated than gifting cash, for example:
- If you dispose of an asset, you are deemed to have sold it at market price for Capital Gains Tax (CGT) purposes, even if you give it away
- Any notional profit on the investment will be considered a capital gain. If you realise gains of over £12,300 in the current tax year, you will pay a tax of either 10% (for a basic rate taxpayer) or 20% (higher and additional rate taxpayers) on the excess
- Assets transferred between spouses or civil partners are ignored for CGT purposes. You could pass assets to your spouse first before making a joint gift. You would then have two annual exemptions (£24,600) available
- If you give away assets that have made a loss, no tax will apply. Losses can be used to offset gains realised elsewhere.
If you die, your funds and shares pass into your estate. The new ‘base cost’ for the investments is the value at the date of death. This effectively wipes out any potential tax liability on gains.
Additionally, your estate and your beneficiaries will each have their own annual exemptions. Your estate could realise up to £12,300 worth of capital gains without tax liability. Each beneficiary could then realise a further £12,300. Remember, these exemptions only need to be applied to gains which have occurred after the date of death.
It can sometimes be more efficient to pass on investments via your Will rather than during your lifetime. A financial plan can help you to navigate the options.
Investment bonds are slightly different, as there are no immediate tax implications on giving them away. Bonds are split into segments, which means you can gift, for example, 1/10th of your investment at a time. Instead, the gains remain intact and could result in a tax liability for the beneficiary when they eventually encash the bond.
Bonds must be encashed on the death of the last life assured, which may result in tax liability for the estate or the beneficiary. If you are not the last life assured, the bond can remain in force.
As bonds work differently from other investment types, a financial plan can help to determine if they will meet your intergenerational wealth planning objectives.
Are pensions subject to IHT?
Pensions are not included in your estate for IHT purposes. The tax treatment of money purchase pensions (such as a Personal Pension, SIPP, or Stakeholder) on death is explained as follows:
- On death before age 75, the full fund can be passed on to your beneficiaries, free of tax
- After age 75, each beneficiary will be taxed at their own marginal rate on any money they receive. However, they will have flexibility over how and when they draw the pension and can even pass it on to their own children.
If you have other investments, it can be worth drawing on these for as long as possible, while leaving pensions intact. Not only do pensions benefit from preferential tax treatment on the funds, but they can also be passed on without IHT.
The rules are different for final salary or defined benefit pensions. Most schemes offer a spouse’s pension and some provide a lump sum in addition. While a defined benefit pension offers valuable guarantees, the options for passing money on to your loved ones are limited, and you may wish to make provisions elsewhere.
Can I transfer my pension to my child?
You cannot pass a pension to your beneficiaries while you are alive. In order to pass value, you would need to withdraw money from your pension first, which could result in a significant Income Tax liability. For this reason, pensions are not usually the best option for giving away money during your lifetime.
Paying into a pension for a child or grandchild can be extremely efficient and ensures that they cannot access the money until at least age 57. You can contribute up to £2,880 per year into a pension for a child (or anyone else with no earnings) and tax relief of £720 will be credited, resulting in a gross contribution of £3,600.
Can I gift my home to my child?
The Family Home
Passing on the family home is an important goal for many people starting to think about estate planning. Tax legislation has taken this into account with the introduction of a Residence Nil Rate Band (RNRB). This works as follows:
- Each individual has an additional nil rate band of £175,000 (on top of the standard £325,000 per person) to set against the main residence. Couples can use both bands, resulting in total relief of £350,000 (a total of £1million – including two lots of £325,000 also)
- The value of the property will be used if this is under the RNRB
- The property must pass to direct descendants
- The relief is withdrawn on estates valued at over £2 million at a rate of £1 for every £2 over the threshold
- The relief may still apply if the family home has been sold or downsized after 8 July 2015.
Alternatively, you may decide to give away your home during your lifetime. Remember, this is only effective for IHT purposes if you either move out of the property or if you pay market rent to the person you gifted the property to. Assuming these conditions apply, the gift will drop out of your estate after seven years.
Helping Children onto the Property Ladder
Helping children buy their first home is a key milestone in many financial plans. There are a number of ways to do this:
- Gifting the money for the deposit
- Making a loan (remember, this stays in your estate unless written off)
- Acting as a guarantor so that they can access a more favourable mortgage deal
- A family offset mortgage allows parents to hold their savings alongside their child’s mortgage. This can improve the deal offered, as well as reducing interest payments.
Do you want to know more about securing your children’s financial future? Read our blog here.
How do you pass a business to the family?
Having your children carry on the family business can be extremely rewarding, as well as tax-efficient.
If you pass your business shares on to your children, you can potentially benefit from Gift Holdover Relief. This means that no CGT will be payable on the transfer. The business can be passed on indefinitely in this way, only becoming taxable if it is eventually sold. The first £1 million of any gains realised from business assets qualifies for Entrepreneurs Relief, which reduces the tax rate to 10% rather than 20%.
Gifting shares to a family member
Gifting shares can be complex. The value of a company is not strictly apportioned according to shareholding – owning 60% of the company is worth more per share than 20% as it includes a higher degree of control. It is vital to take advice if you are gifting company shares, as the gift may be worth more or less than you think.
On death, most business assets will qualify for Business Relief, which offers either 50% or 100% relief from IHT.
Even if you don’t own a business, you can still benefit from Business Relief by investing in certain types of shares, for example, Enterprise Investment Schemes or Alternative Investment Market stocks. These are high risk and not suitable for everyone, but could offer tax savings as part of a diverse investment strategy.
Can you gift money from a trust?
Gifting money or assets into trust is a great way of reducing the value of your estate without giving up full control. A trust could benefit you if:
- You are prepared to make a gift now but do not want your beneficiaries to receive all of the money right away
- You would like to have flexibility over how the money is distributed and for what purpose
- You would like to provide for a group of beneficiaries, for example, your children and other descendants. This can include grandchildren who have not been born yet
- You wish to protect your wealth against bankruptcy, divorce, loss of capacity, or even poor decision-making
- You want to provide an income for one party (for example, yourself or a spouse), while preserving capital for someone else (such as your children).
You can set up a trust even if you don’t want to make a gift from capital. A whole of life policy, placed in trust, can ensure that your beneficiaries receive a lump sum on your death. This is outside your estate for IHT purposes. Life policies can be a useful method of transferring wealth, particularly if it’s possible that your own assets will be spent during your lifetime.
It is always worth seeking advice if you are considering setting up a trust as the different structures vary in terms of flexibility, access, and tax treatment.
Can I gift money through a family investment company?
An increasing number of families are looking for alternatives to trusts that offer greater flexibility and tax efficiency. A family investment company is one such option. This works as follows:
- A limited company is set up, with the family members as shareholders
- Cash is transferred to the company, usually in the form of a director’s loan
- This can be invested in shares, funds, or even property
- Shares are issued to family members which can include varying rights in terms of voting and entitlement to capital and dividends
- Over time, more shares can be transferred to beneficiaries, reducing the value of the donor’s estate.
An investment company may suit wealthy families who have already made use of trusts and gifting allowances and require sophisticated planning. There can be implications for CGT and IHT depending on the structure of the company. Business Relief is not available on pure investment companies i.e. non-trading companies. Tax advice is essential.
As you spend time with your loved ones over the festive period, think about where you would like to be next year or even ten years from now. What are your wishes for your family, and can you help them achieve their goals?
The period between Christmas and New Year is an ideal time for reflecting on what you have and making plans for the future.
We are a firm of Independent Financial Advisers based in London. Please don’t hesitate to contact one of our Chartered Financial Planners if you would like to find out more about transferring wealth to the next generation.
This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.