According to probate and estate specialists an estimated £5.5 trillion will be changing hands – transferred between different generations – in the next three decades, either through inheritance or gifting. But with people living longer, and needing greater assistance with healthcare and daily living, the transition can be complicated. That’s why more people need to start thinking about how to cascade ‘intergenerational wealth’ down to children or grandchildren.
What is intergenerational wealth planning?
Intergenerational wealth planning is simply about taking steps to choose when and how you want to pass on your wealth to your children or grandchildren. Whether you are planning to leave behind a life-changing inheritance, or just enough to help your loved ones feel slightly better off, it’s important to understand the impact that inheritance tax (IHT) could have on the value of your estate. Every year, thousands of people pass away and leave behind an IHT bill for loved ones to deal with, drastically reducing the value of their inheritance. With the right planning in place, you can pass on more of your wealth, reduce or even eliminate any IHT due on your estate, and see your loved ones put the money to good use while you’re still alive.
What are the current inheritance tax thresholds?
As a reminder, everyone in the UK aged 18 or over has a personal IHT allowance known as the nil-rate band. This nil-rate band currently stands at £325,000. If the value of an estate (money, property, and possessions) when a person dies is below this amount, there is no IHT to pay. However, if the estate is valued above £325,000, the beneficiaries of the estate will be required to pay IHT at a rate of 40% on the amount over the threshold.
However, if you pass your home on to your children or grandchildren, your estate can also claim the residence nil-rate band, which is an additional IHT allowance that can increase the value of your estate excluded from IHT to £500,000. This allowance is only available provided you leave the home to your direct descendants, and the allowance is reduced if the total value of the estate is more than £2 million.
Making gifts out of your wealth before your death is an excellent way to reduce the inheritance tax on your estate, but it’s important to understand the rules around making gifts before you start giving it all away. HMRC gives everyone an annual gifting allowance of £3,000 – called the ‘annual exemption’. You can carry over the £3,000 annual exemption to the following year if you don’t use it, but only for one year.
You can also make small gifts (no more than £250) to as many different people as you wish, as long as you haven’t given them a gift as part of your £3,000 annual exemption. Wedding gifts are also IHT-exempt up to certain limits (up to £5,000 for your child, £2,500 for your grandchild or great-grandchild, and up to £1,000 for anyone else). Any gifts made between spouses or civil partners are completely IHT-free.
Potentially exempt transfers
Making gifts of larger amounts than £3,000 is permissible, but it does run the risk of triggering an IHT bill – particularly for people who are elderly or in poor health. This is because for a gift to become completely free of IHT, the individual making the gift must survive for at least seven years from the date the gift was made. Lifetime gifts of this type are known as ‘potentially exempt transfers’.
The IHT bill due on a potentially exempt transfer reduces on a sliding scale (also referred to as ‘taper relief’) for each full year the giver survives. So, if the giver dies within the first three years of the gift being made, the gift will be liable to the full 40% IHT charge – paid by the receiver of the gift. The IHT charge on a potentially exempt transfer falls by a further 8% for each year the giver survives (so charged at 32% if death occurs between years 3-4, charged at 24% if between 4-5 years, and so on), until seven years have passed, when the IHT bill reaches 0% and the gift becomes fully exempt.
Inter vivos policies
In cases where a large gift has been made, or could be made in the future, an inter vivos life insurance policy can protect against the possibility of a potentially exempt transfer failing, and falling back into an individual’s estate. Roughly translated, inter vivos means ‘between the living’, and it can be used to pay a lump sum in the event of a person’s death during a specific timeframe. The giver can arrange for the policy to have a fixed seven-year term, with the amount of cover it provides reducing to match the reduced IHT liability as taper relief starts to take effect. Although the cover reduces, the premium to pay for this type of insurance policy typically remains fixed for the whole seven years.
However, before choosing to set up a gift inter vivos policy, it is important to determine whether the available taper relief will apply in your own circumstances. This is because any lifetime gifts made will first be allocated against your nil-rate band when the gift is made. It is also worth noting that taper relief is applied to the rate of IHT to pay, not to the value of the gift. So, if a gift falls within the nil-rate band, the rate of tax is zero and therefore taper relief has no effect.
Over the course of this year, we’ve had more clients talking to us about estate planning and ways to reduce an IHT bill for their loved ones. Fortunately, there are lots of intergenerational wealth planning options available to clients looking to pass on more of their wealth to their children and grandchildren, and who would much prefer to see their wealth being enjoyed during their lifetime.
If you are interested in discussing IHT or your estate with one of the experienced financial planners at FAS, please get in touch here.
This content is for information purposes only. It does not constitute tax planning or financial advice.