It is no great secret that today’s young people are at serious risk of being poor in their retirement.
While asset-rich baby boomers hoard their wealth, eight years after the financial crisis, working age people are stuck with low wage inflation, and depressed returns on any savings they can scrape together after paying their rent or mortgage and living costs.
A report released today by Brewin Dolphin and the Centre for Economics and Business Research lays bare the extent of the pension and savings shortfall adults under the age of 45 will face when they reach retirement.
This deficit could be narrowed, however, if their parents and grandparents could pass on their wealth in a more tax-efficient way.
The wealth manager is calling on the government to consider new tax incentives which would allow the baby boomers currently in or close to retirement to gift more of their wealth to younger generations years before their death, so it has the time to benefit from investment growth.
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Current levels of pension saving among the UK’s young people is worrying. A survey of 11,000 18-44 year-olds found that, on average, they consider an income of £30,000 a year to be enough to live on comfortably in retirement.
But the average expected size of their pension pots when they retire is just £175,000 – £550,000 beneath the £725,000 required to buy them the annuity they’d need at today’s rates. A quarter of respondents admitted to saving nothing at all.
The expectations of young Londoners were even more fanciful. They wanted £37,000 a year for their retirement, but are expected to have saved just £217,000 by the time they retire – a £819,000 shortfall on the £1,036,000 figure needed to buy an annuity that would meet their expectations.
Even those on higher incomes are struggling, with more than a fifth of households with a total income of £60,000-£100,000 saving less than 1 per cent of their net income.
So how can the older generation help? Not only are final salary pensions and the state pension triple-lock ensuring that retirees incomes are rising faster than their working age descendants, but Brewin Dolphin estimates that the UK’s over-65s are sitting on housing wealth worth a massive £1.3 trillion.
Under current IHT rules, any assets which exceed the nil rate band of £325,000 per person are subject to a 40 per cent tax when their owner dies. This limit will rise in April when everyone will be entitled to a “maximum residence nil rate band” worth £100,000, which will increase by £25,000 every year until 2020-21.
From this date, a married couple will effectively be able to pass on assets worth £1m tax-free to their children and grandchildren.
There are tax-efficient ways to pass on wealth. Currently, you can make gifts to your grandchildren, including contributions to a junior Isa (Jisa) or a junior pension. But there are catches.
“You need to survive seven years after you make the gift,” says Jeannie Boyle, chartered financial planner at EQ Investors. “And once your total estate is over £2m, the residential nil-rate band is reduced at a rate of £1 for every £2 you exceed it.
"So if you’re worried about breaching this limit, start giving away your assets to get them out of your total estate and lower its value below the £2m mark.”
The best method for leaving wealth may be through your pension. Under last year’s liberalisation, you can bequeath any wealth in a private pension onto nominated beneficiaries tax-free if you die before you reach 75, even if you have already withdrawn from it.
Even after that, nominated beneficiaries won’t pay IHT, only income tax at their marginal rate. “Using your pension is the most tax-efficient way to leave your assets,” says Boyle.
But waiting until death to pass on all your wealth in one go means that beneficiaries miss out on years of compounding in asset classes which could generate higher returns.
If older people made regular contributions to a grandchild now by saving into a Jisa or a pension, “the potential long-term investment growth, the effect of compounding and the IHT savings from this approach means that one silver pound gifted and invested today could be worth three times as much to grandchildren later on,” says Liz Alley, divisional director of financial planning at Brewin Dolphin.
Her firm is urging the government to implement a change to the tax regime which would allow older people who gift 10 per cent of their estate to their grandchildren to reduce their IHT rate from 40 per cent to 36 per cent, and exempt any gifts directly into their grandchild’s Jisa or a pension from the seven-year IHT rule.
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Maximising a grandchild’s Jisa allowance every month (£340) until they reach 18, assuming 2 per cent interest, would grow £73,440 of contributions to £88,995, and could be used for one off costs such as buying a car, a wedding or a house deposit, according to Brewin Dolphin.
A grandparent could also take advantage of their grandchild’s pension allowance by saving up to £240 month into a pension for them, which would receive tax relief of £60 a month and grow to £64,800 by the time the grandchild reaches 18. Assuming 2 per cent growth, by the time the child reached 60, the savings would be worth £180,391.
If such Jisa and pension saving were done for three grandchildren, it would remove £285,360 from an estate, according to Brewin Dolphin’s figures. If that amount grew at 2 per cent a year and was subject to 40 per cent IHT, the same sum would be worth just £213,942.