Using the Bank of Mum and Dad to pass down wealth
Recent research has highlighted the importance of The Bank of Mum and Dad in helping young people start their adult lives, marriages and, most commonly of all, get themselves on the property ladder. However, passing down wealth through the generations takes careful planning. Here we look at how long-term objectives for family finances can be met.
Billions of gifts and loans
Parents in the UK gift or loan their children an estimated £17 billion each year, mostly to help with buying a house or as a wedding present, according to recent research from the Institute for Fiscal Studies (IFS).
Most transfers come from parents aged over 50 to children in their late 20s and early 30s. Around 30% of young adults receive at least one substantial transfer (of £500 or more) over any eight-year period.
The majority of this transfer comes in the form of gifts while £3.3 billion is in the form of loans, although these are frequently lent with very favourable terms and low expectation of them being repaid.
The property ladder
Half of the value of gifts received was used for property purchases or improvement. Those using transfers for this purpose received over £20,000, on average. Those in the least wealthy third are relatively more likely to report using gifts for the purchase of a new car, to pay off debts or for educational expenses.
Whatever the purpose of a gift or loan, it can attract the attention of the tax authorities with the potential for inheritance tax (IHT) or capital gains tax (CGT) liabilities.
Many smaller or regular lifetime gifts are exempt from IHT, while larger gifts may become exempt after seven years, so a strategy of making gifts in your lifetime can substantially reduce your taxable estate on death.
You can also take out life insurance to cover any IHT which might be due following your death within seven years of making larger gifts. However, potential CGT must be taken into account with this option.
IHT is currently payable where a person's taxable estate is in excess of £325,000. Therefore, if you own your own house and have some savings, your estate could be liable.
The good news is that there are a number of allowances and strategies that may help to reduce your liability to IHT. This may include utilising the residence nil-rate band, which was introduced with the intention of enabling a 'family home' to be passed tax-free on death.
It could be said that the art of IHT planning is to give away as much as possible during your lifetime, while still keeping enough to ensure that you and your spouse can live a comfortable and fulfilling retirement.
The full rate of tax is 40% on the estate value in excess of £325,000. Taxable gifts made up to seven years before death are added back into your estate and tax is calculated on the inclusive value. But to the extent that such lifetime gifts made between three and seven years before death exceed the tax threshold, the associated tax is discounted by up to 80%.
In addition, the 'residence nil-rate band' (RNRB) applies where a residence is passed on death to direct descendants, such as a child or a grandchild. The RNRB is set at £175,000 for 2022/23.
Trusts allow you to make gifts without giving the recipient complete control over the asset and/or the income it generates. Gifts into trust may result in an IHT liability, depending on the nature, timing and terms of the gift and the value of other chargeable gifts in the preceding seven years. Ten-yearly and exit charges may also arise.
You can also create a discretionary trust in your Will to allow your trustees to decide how your assets should be distributed, giving a (non-binding) letter of wishes and taking into account all relevant circumstances at the time. This option has the advantage of deferring all CGT charges.
How we can help
It is important to remember that planning to minimise your IHT liability is a team effort. The scope for making substantial savings may be missed unless professional advice is sought. Please do not hesitate to contact us for assistance with planning your family's financial security.