At least, some good news for Generation Y. According to a recent Royal London survey, a cascading wall of wealth – around £400bn – is predicted to descend from the property-owning “grandparents’ generation”, as more pensioners plan to restructure their estates to help the younger generations financially. However, with this generosity comes potential tax traps of which both donors and beneficiaries need to be aware.
The survey focused on three main generations – the grandparents’ generation (over 65s), the “sandwich generation” (aged 45-64) and the “children’s generation” (aged 25-44). The wealth gap between the grandparents’ and children’s generation has been well publicised, with the latter set to become the first demographic not to earn more than their parents, while the former are seeing their pension income rise faster than the working generation, and are set to enjoy a comfortable retirement.
This is helping to incentivise the grandparents’ generation to pass on assets during their lifetimes, and the sandwich generation to potentially divert inheritances to their own children.
Giving in life
Lifetime giving has inheritance tax (IHT) consequences. If the donor fails to survive a lifetime gift by seven years (“the seven year rule”), IHT is payable on the gift at death at the rate of 40 per cent to the extent that the donor’s IHT nil-rate band (currently £325,000) is exceeded. Gifted assets can also be treated as still forming part of the donor’s estate for IHT purposes, if the donor retains some benefit in the asset in some way.
The most tax-efficient method of lifetime giving for the sandwich generation who receive an inheritance and want to pass it on to their own children is to pass the asset on by deed of variation. For IHT purposes, such a gift is treated as if it is made in the will of the deceased, bypassing the original sandwich generation beneficiary, and avoiding payment of IHT on the same asset twice.
An alternative approach is for the grandparents’ generation to pass assets directly to grandchildren as lifetime gifts. The report found that one-third of the over 75s had already given lump sums to their grandchildren, primarily for house purchases or weddings.
The IHT seven-year rule can be avoided by making IHT-exempt gifts. Regular gifts made out of an individual’s surplus income are exempt, and each individual has an IHT annual exemption of £3,000, which can be given away tax-free each year, or rolled over to the next tax year. Gifts to charities are generally exempt, and certain assets such as business property (including Aim shares), and agricultural property, can qualify for relief from IHT.
However, making an outright gift will not always be appropriate, especially if large sums are involved and/or the recipient is not mature enough to manage the funds, or at risk of divorce or bankruptcy.
To guard against these risks, trusts can be used. Discretionary trusts are the most flexible form, allowing both children and grandchildren to be included in the class of beneficiaries. The grandparent settlor can guide the trustees on how and when to make distributions from the trust by providing a Letter of Wishes.
There is an up-front IHT cost to creating a trust, but not if an individual limits the gift to the amount of their available nil-rate band, and settles this amount into the trust every seven years. Trusts are generally subject to an ongoing IHT charging regime, principally a charge at every 10-year anniversary at a maximum rate of 6 per cent. However, because no individual child or grandchild owns the trust assets, there will be no IHT (at 40 per cent) on any of their deaths.
Many will feel that the 10-year IHT charge is a price worth paying for this longer term IHT saving, and the asset protection and estate planning benefits that trusts provide.
Philanthropic grandparents who are looking to minimise IHT on death so that a greater proportion of their estate can be passed on to the younger generations have tax saving options available by making charitable gifts as part of their will. If 10 per cent of a deceased’s estate is intended for charitable giving, IHT is reduced from 40 per cent to 36 per cent, which could represent a considerable saving.
Not so simple
Lifetime giving by the grandparents’ generation could help bridge the wealth gap between them and younger generations, and also save IHT. But when large sums of money and valuable assets are involved, it is not always a simple case of handing the money, or asset, over. Advice should be taken on the IHT and possible capital gains tax implications. This form of estate planning could fast become standard on personal to-do lists.