INHERITANCE TAX: HOW TO PREPARE FOR THE GREAT WEALTH TRANSFER

“I’m rags to riches — but scared to go back to rags,” says Harry, who is in his 50s, and contemplating what to leave to his two 20-something sons after he dies. “I have properties and an operational business with investments. What do I do?”

Harry and his family are part of the Great Wealth Transfer. Over the next 20 years, as his generation ages and hands down its assets to descendants, millennials and Generation Z are set to inherit a staggering amount of money: £1tn is expected to change hands in the UK in the 2020s alone.

But deciding how to transfer that wealth is tricky for a lot of families. Inheritances can be emotionally fraught, becoming a source of conflict and tension. Plus, younger people receiving large amounts of money will need to make decisions about investing and saving that they may have never had to consider before.

Then there’s tax. Last year, HMRC collected a record-breaking £7.5bn in inheritance tax (IHT). So far this year, it has banked £4.6bn between January and July.

People are panicked that the seven-year rule in particular might go

Nimesh Shah, chief executive of tax experts Blick Rothenberg

And since prime minister Sir Keir Starmer’s address in the Downing Street rose garden on Tuesday, where he described how the autumn Budget will be “painful”, expectation is growing that IHT could be part of tax reforms. With the Budget looming on October 30, and chancellor Rachel Reeves needing to fill the £22bn “black hole” in the nation’s finances, change may be on the cards.

“The problem the government has is actually that inheritance tax brings in so little,” says Nimesh Shah, chief executive of tax experts Blick Rothenberg: only about £8bn out of £800bn in total tax receipts. The challenge, therefore, could be to get more people paying the tax — currently only about 4 per cent of people do — and to increase what each estate pays.

While the headline rate might not change — at 40 per cent it is already one of the UK’s highest taxes — the government could cut back certain allowances and reliefs, such as those associated with business and agricultural properties, says Shah.

Currently, everyone can pass on up to £325,000 before IHT applies due to the nil-rate band, which has been frozen until 2028. An additional £175,000 residence nil-rate band is available, where homeowners leave a property to their direct descendants (though this tapers on estates over £2mn).

At the moment, since married couples can pool their allowances, an estate must typically be over £1mn prior to any IHT being due and anything you give away up to seven years before you die can be counted — charged at the full 40 per cent if you die within three years, with a tapering relief applied over the four years before that.

“People are panicked that the seven-year rule in particular might go,” says Shah. He says he has seen an increase in clients, “not just since the election, but since Tuesday”, calling to accelerate their plans to gift money to their descendents early, and to start the seven-year clock ticking under the current regime in case anything changes in the autumn Budget.

“Without having a crystal ball, having a financial plan that can easily and swiftly adapt to these changes is essential,” says Anthony Hardy, chartered financial planner at Kingswood Group.

The first part of that plan, regardless of what happens in October, is working out what you want to achieve — and this is not as simple as minimising your IHT liability. “When we first started in the industry, it was typical for parents to ask how they could maximise what they passed on to their kids. Nowadays they are more likely to ask us how they can put limits on what they inherit,” says Katherine Waller, co-founder of wealth manager Six Degrees.

According to Olly Cheng, financial planning director at wealth manager Rathbones Group, the biggest concerns parents have is about spoiling or demotivating their children. They want the money to give them a leg up but not do everything for them (“Feather boosting, rather than feather bedding,” is how he puts it). Divorce is another primary concern.

Both of these issues, as well as fear of bankruptcy, can be addressed using discretionary trusts — legal agreements that allow the “settlor” to leave money or assets, with trustees to decide how and when to distribute them to the beneficiaries. 

My kids have [known they’ve] been millionaires since 2017 but you’d never know it

Steven, FT reader

Harry Bell, director of financial planning at Charles Stanley, says that gifting into a trust is a popular way to manage succession. There is still a seven-year holding period required before the assets are out of the estate for IHT purposes, however it enables those gifting to maintain control of the assets as trustees. “This works well when the beneficiaries are young, or the trustees do not feel that the beneficiaries are mature enough to inherit directly,” he says.

Discretionary trusts can either allocate funds during your lifetime or be set up in your will, to come into effect when you die.

However, there can be complicated tax charges and costs for setting them up, so they’re not for everyone. “Trusts can be complexity for the sake of complexity,” says Cheng.

One thing to keep in mind is that there is no “right” answer when it comes to structuring an inheritance, says Ian Dyall, technical estate planning specialist at Evelyn Partners. “Literally every case is different. Even if the finances are similar, the family circumstances can be different. So it’s a creative area of financial planning trying to match solutions to the problems.”

Steven, who responded to our reader callout, favours an approach that some might consider radical transparency. “My kids have [known they’ve] been millionaires since 2017 but you’d never know it,” he says. “They drive six- and 10-year-old VW hatchbacks and are well grounded and appreciate their good fortune.” He doesn’t believe the knowledge of their significant safety net has demotivated them.

“Some years ago I had a philosophical debate with a leading fund manager who had kids of similar ages and had similar amounts set aside for them. He was mortified that I had told my kids what their ‘pots’ were . . . But I trusted they had good values and common sense,” he says. “So far so good.”

Advisers say the most effective tools to make an efficient transfer of wealth are often the simplest: wills, gifting and communication.

Making sure a will is up to date is a sensible starting point, and will help shape thoughts on whom you wish to benefit from your estate, not only on death but also during your lifetime. Marriage, divorce, births and deaths can mean a will no longer reflects your wishes or takes into account changes in legislation and allowances.

There is real joy in lifetime gifting, as you might get to see the recipient go to university, buy their first property, spend more time with their children or stop work earlier

Carla Morris, wealth director at RBC Brewin Dolphin.

And while parents’ natural tendency is to leave money to children, it may make more sense from a tax perspective to skip a generation. A bare trust — a simple type of trust that allows irreversible gifts to a beneficiary — is often used by grandparents to set aside money for grandchildren who are too young to receive and invest or spend a gift.

Furthermore, when a grandparent dies, parents cited in their will who don’t need the money can allow it to skip a generation via a deed of variation, a legal document that allows beneficiaries to make changes to a deceased person’s will. The deadline for doing this is two years from the death of the grandparent.

For those with a potential IHT liability, the first and main consideration should be to spend more or give away more during your lifetime, and as early as you can. But do it carefully. One of the biggest mistakes people make is starting their tax planning too late, Dyall says.

Under the current rules, give everything away and live for seven years and your IHT liability will be zero — though Shah wonders if a lifetime cap could be introduced at the next Budget.

While parents are still earning, they can make gifts out of income, which can fall outside an estate straightaway. But make sure your record keeping is good. Cheng recommends getting hold of the IHT gifting form that’s used and recording gifts out of income on that because it’s the format that HMRC will eventually require.

You can also give away up to £3,000 worth of gifts each tax year without this being added to the value of your estate. This is known as your “annual exemption” — which, frustratingly, has not changed since 1981. There are also allowances for small gifts and gifts on marriage. But be warned, says Dyall: “Theoretically, if you’re giving away more than £3,000 anything in excess of that is a potentially exempt transfer.” You could, after all, get hit by the proverbial bus.

Some advisers recommend considering insurance either to cover the seven-year period if making a large gift or to reduce the IHT liability on your estate after death. The cost will depend on the amount to be insured, the donor’s age and their health. 

Dr Andrew Molyneux, a retired NHS consultant, chose a more immediate route. “As one of the baby boomers born in 1947, I am one of the lucky generation,” he says. He has benefited from growth in property values over 50 years, plus a final salary pension scheme from more than 40 years working in the NHS.

£325,000The limit of the IHT nil-rate band, which is frozen until 2028

So he released equity in his property (worth more than £1.5mn) via a retirement interest-only mortgage, enabling him to pass on substantial capital to his children. “Many of these payments have now passed out of the IHT seven-year period, but I will continue to pass over significant capital sums in the near future as I downsize property again,” he says.

“There is real joy in lifetime gifting as you might get to see the recipient go to university, buy their first property, spend more time with their children or stop work earlier,” says Carla Morris, wealth director at RBC Brewin Dolphin.

But parents and grandparents must also be mindful of a generational divide developing on attitudes to wealth transfers.

“With over 90 per cent of the country’s wealth held by Generations X and older, large numbers of millionaire inheritors are set to be created, and we already see that many hold different values and a strong sense of purpose for their wealth and its potential impact,” says Jamie Banks, head of wealth planning UK at Julius Baer International.

David Clarke is 34 and lives in Liverpool. He inherited £100,000 at age 24 after his mum died but gave it away by setting up a project, detailed at Wealthshared.co.uk. After sending letters to 600 households in his local area, Clarke created a panel of 12 strangers whom he invited to discussion sessions with an independent facilitator. They decided to use the money to address deprivation in his local area.

He says: “I made the decision to give it away partly because I was not comfortable with having lots of inherited wealth. I didn’t feel great about my life being defined by the lottery of inheritance. I also want to succeed in life on my own terms.”

Becky Holmes, 29, is a co-founder of the Helvellyn Foundation, set up with inherited family wealth from her father’s business. She says: “When I worked in graphic design in my early 20s I felt uncomfortable and embarrassed talking about wealth. I almost wished I had to save for a mortgage, so I could feel more like my friends and have something to work towards,” she says. “I realised I needed to find a new purpose. Conservation became that after walking around for a few years with a sense of guilt about having lots of money without earning or particularly deserving it.”

In the end, successful wealth transfer will rely on good conversations within families. But these aren’t happening enough because the British are often shy about talking about wealth.

One in 10 “high net worth investors” hold back from discussing wealth planning due to a fear of disagreements, according to research from Rathbones, a wealth manager. A further 27 per cent say they find talking about money and wealth planning with their immediate family to be uncomfortable. Meanwhile, almost half (49 per cent) of under-35s say they expect to receive an inheritance, but haven’t discussed this with their family. 

A good adviser will chair a joint meeting with parents and children to set this straight. Cheng says: “Money gets equated to love when people pass away. But you can negate that by sitting around a table and getting buy-in from your children on what you want to achieve.” 

2024-08-30T04:04:48Z dg43tfdfdgfd