Having a child is a life-changing experience. On top of the upheaval to your home, the challenges of those early sleepless nights and the physical recovery for Mum, it’s hard not to also begin to consider the financial aspects of the new arrival.
Many new parents consider the financial side of starting a family well before that.
Concepts like inheritance tax, which previously might have been lumped in the ‘don’t care pile’, suddenly occupy a tangible space in your mind. This new phase prompts thinking of your children's financial future, which in turn often leads to thoughts about inheritance in general.
Even your own.
But of course that throws up challenges as well. Is it actually possible to minimise the tax burden by planning ahead? How should you discuss this with your parents? Will they think you’re secretly wishing they’d fall off the perch so you can access their cash?
None of these questions are easy to answer (well, hopefully the last one is), but they’re vital when it comes to managing multi-generational wealth. Done correctly, it can mean that everyone ends up with the money they need, when they need it, while maximising the overall family financial situation.
Multi-generational wealth planning is even more important in the UK than in many other countries, for the existence of one simple form of tax. Inheritance Tax (IHT). Many investors get a shock when they first see their potential IHT liability laid out in front of them, and it’s often a catalyst to begin planning.
The problem is that this often happens too late. We’ll get into that more in a minute, but let’s first quickly cover how IHT works.
IHT is the UK's version of a "you-can't-take-it-with-you" tax, as it’s tax on the estate (the total sum of property, money, and possessions) of someone who has passed away.
The way it works is that everyone gets a tax-free threshold of £325,000, which is known as the Nil Rate Band. If the deceased owns their own home, they get an additional Nil Rate Band of £175,000 to bring the total allowance to £500,000.
Anything above that can potentially be taxed at 40%. That's a chunky tax bill for the estate.
It's also worth noting that anything left to your spouse or civil partner isn't taxed until they too pass away. So if the first person in a couple to die leaves everything to the other, they can also pass on their unused tax-free allowance. That takes the total allowance for a couple to £1m. It’s important to note that this is only for married and civil partnerships, other couples won’t receive their partners IHT bands and the estate will pay IHT based on a calculation for a single person.
Notably, UK pension assets are not included in the calculation for IHT.
Of course, there are a few more complexities and details, but that's the general overview. It’s easy to see what a big impact this can have for even relatively middle class families.
Let’s look at an example, with an elderly couple who have the following assets:
Asset - Value
Main Residence - £1,200,000
Bank Accounts - £100,000
Investment Accounts - £1,350,000
Buy to Let Property - £520,000
Artworks - £20,000
Vehicle - £40,000
Personal items (Jewellery etc.) - £20,000
IHT Allowance - £1,000,000
Net Estate - £2,250,000
IHT Liability: £900,000
That’s right, this estate would receive a tax bill from HMRC for almost a million pounds. Now it’s not to say that this particular estate can’t afford that, but nevertheless that’s a major portion of family wealth that is simply going to be handed over to the government.
For a family with assets of £10 million, that figure would jump to £3.6 million!
It’s no wonder many wealthy families work very hard to limit the damage of inheritance tax.
The most effective way to navigate these issues is to take a ‘whole family’ approach. This may seem unusual for some, but it’s the norm when it comes to the super wealthy. Families like the Branson’s or the Zuckerbergs don’t operate in silos, managing their own individual wealth in isolation.
Generally, they maintain family offices and wealth advisors who look at the family's financial situation in totality, providing advice on how best to allocate assets between the various members, and how to protect the assets as they pass to the next generation.
Now while most of us aren’t in the position to create a dedicated family office like that, any family can adopt a similar approach to their finances. In fact, Rosecut is launching our very own family office service that offers this comprehensive approach to family finance management and growth.
It’s key that this approach is decided on early. A lot of the planning that can be done needs to take place years in advance of someone passing away. Even the simplest form of IHT planning, gifting, requires the gifter to stay alive for 7 years for the gift to fall outside of the estate.
This isn’t an approach that can be rushed through at the last minute, but if done correctly, it provides significant benefits to the family.
With all that said, there’s a very common roadblock to doing this the right way. Having awkward conversations.
At the heart of successful multi-generational financial planning lies open and honest communication about money, expectations, and future plans. But let’s be honest, death and money are just about the most uncomfortable topics a family can discuss, and family wealth planning covers both of them.
The way to ensure the conversation happens in the right way, is to broach the topic by dealing head first with the concerns family members might have about the discussion. Generally these concerns come from the older generations, simply because they’re the ones who will be potentially handing over money!
Here are a couple of the most common we see.
Gifting is the most clear cut way to minimise Inheritance Tax, but people are often worried about giving away too much. ‘What if I need the funds for my own care?’
It’s a valid concern, but one that comes purely from having a lack of information. If you don’t know much you’re likely to need in the future, it will never seem like you have enough. Completing detailed cash flow modelling, with significant buffer amounts added as a contingency, can provide some real clarity for the older generation that they will still have enough.
Indeed, this is the number one objective of multi-generational planning. Step one is always to ensure that the oldest in the family have enough for their own needs. If they truly don’t or it’s a bit touch and go, then no planning is needed because the estate will likely fall below the £1m IHT threshold.
In having this conversation, it’s vital that this is highlighted. The number one objective is to ensure that they have enough for their own costs of living.
There are a ton of reasons for this. Whatever they may be, many people don’t want to hand over their money to their children with no control over how they spend it.
Luckily, there are many ways that gifting can be done into trust structures, allowing the gifter to remain as trustee and in charge of all the decisions regarding the money. They can choose how it’s invested and how and when distributions are made to the beneficiaries.
Of course every family is different, and there will be different concerns for every individual and couple. The important thing is not to ignore these, but to address them from the outset to ensure a constructive conversation can happen.
So this article isn’t going to be a complete rundown of all of the different strategies that can be employed. After all, this is an incredibly complex area and there aren’t really any ‘rules of thumb’ like you’ll find when it comes to typical investing.
Below is a brief overview of some of the strategies that can be considered, but if you try to implement them without professional advice, they could end up costing you a lot of money for very little benefit.
This is the easy one. You can give any amount, to anyone, and if you live for 7 years after the gift, the asset falls completely outside your estate. It’s also not an all or nothing approach, and if you pass away between 3 and 7 years from the gift, a sliding scale is applied to the gift amount.
As we said at the outset, there are no ‘magic’ trusts that avoid IHT completely, but there are many different types of trusts that can be utilised for gifting. Some of these allow the gifter to maintain access to the income from the investments while gifting the principle, while others allow for the original capital to be pulled back out in the future if needed.
Some investments are exempt from Inheritance Tax. Pensions are the obvious ones, but there are a range of other investments which qualify for what’s known as Business Property Relief (BPR). Despite the name, this isn’t related to commercial real estate, and the definition of what counts as ‘business property’ is quite wide. Assets that can count can include shares in certain listed companies, equity in private companies, business machinery, land and more.
As long as these assets are held for more than two years, and are still held on death, they receive relief from IHT.
One of the most known are shares in companies listed on the AIM market (still need to evaluate the potential financial return side of things) , but there are a large number of other BPR investment products available on the market.
Similar to a trust, a personal investment company is set up solely for the purposes of managing investment assets. It allows for assets to be removed from the personal estate over time, and can offer additional tax benefits over personal tax given that it is taxed at company tax rates.
Giving to charity is a worthy cause, but it can also be tax effective as well. Gifting 10% or more of a net estate through the Will allows for the rate of IHT to reduce from 40% to 36%. This can be particularly beneficial for larger estates.
As an example, gifting 10% of a £10 million estate would reduce the IHT liability from £3.6 million to £2.92 million. So a gift of £900,000 can be made for a net cost of £220,000.
Simply put, none of this is easy. They’re challenging conversations to have and the practical strategies aren’t straightforward either. But for families who are prepared to work through the issues one by one, they can provide substantial value.
Not only will that lead to better financial outcomes for everyone involved, but it can also improve relationships and limit future conflicts by dealing with concerns and problems upfront.
More money and better relationships in the process, seems like a winner to us!