It can be tax-efficient to make gifts during your lifetime rather than leave everything to your children after you die
You should give thought to the order in which you make the gifts as this can have tax implications
Leaving money to charity can reduce the tax liable on the rest of your estate
Shaken not bequeathed. Daniel Craig’s children, according to the Bond actor in a recent interview, will discover diamonds are not actually forever. Craig, who has a three-year-old daughter and a stepson with wife Rachel Weisz, and an adult daughter with his ex-wife, said that he finds the practice of leaving an inheritance “distasteful”, and prefers to “get rid of it or give it away before you go".
The No Time To Die star’s stance is surprisingly common. Almost one in five people don’t plan to leave most of their money to their kids, according to a survey by Hargreaves Lansdown.
Cutting your kids out of your will is not illegal in England and Wales. “We have testamentary freedom, unlike some other countries which have forced heirship rules,” points out Stevie Heafford, partner at accountants HW Fisher. “In theory, you don’t have to leave your wealth to adult family members” – though there are legal provisions relating to children under 18. And in Scotland, surviving children have a statutory claim to parts of your estate.
Reasons for not bequeathing to children cited by respondents to Hargreaves Lansdown's survey included not wanting to hinder them making their own way in life, concerns about how they’ll spend the money and the risk that their offspring would hope they died.
Alternative options
Fears that heirs won’t cope with the responsibility or assets may be lost in a divorce could be alleviated with family trusts, according to Heafford. The giver maintains an element of control over their disposal, and they are “tax-efficient and protective". A split trust, for example, provides a right to income for one beneficiary, leaving the capital to others. Discretionary trusts can protect family money from debtors and divorce. Trusts come at a cost, but leaving children a legacy in a way that suits parents may be less toxic than disinheriting them completely.
Stipulating in your will for a minimum age at which the inheritance is released is another option.
While disinheriting your children might seem to be more of an emotional decision it can be more tax-efficient – especially if they are older. Inheritance tax (IHT) receipts for July were £32m higher than in June, totalling £571m, according to government figures, and the average IHT bill in 2018-19 was just over £209,000. Alongside frozen IHT nil rate bands, rising asset prices and a heated housing market, increased life expectancy means that a growing number of families are likely to be liable for this tax.
“On average, someone inherits in the UK at age 61 when they may already have their own IHT liability to consider,” says Henny Dovland, business development director at TIME Investments.
Skipping a generation can mean that more money stays with the family. Grandparents, for example, can set up an educational trust with their grandchildren as beneficiaries to cover school fees. Investments or cash up to each grandparent's IHT threshold of £325,000 can be transferred into a discretionary trust and are counted as a potentially exempt transfer so fall outside their estate for IHT purposes after seven years. If your grandchildren are under age 18 you could put money into a Junior individual savings account (Isa) for them, which they can’t touch until age 18.
Another way to avoid IHT, as well as resolve any desire not to pass wealth onto your children, is to leave assets to charity. “It can be a tax-efficient way to create a legacy as IHT is not due on donations,” says Dovland. And if 10 per cent or more of your net estate is left to charity, it can lower the IHT rate on your remaining estate from 40 per cent to 36 per cent.
Even for younger children the tax case for inheritance is not clear cut. “Other than assets which qualify for IHT reliefs, such as business property relief, leaving assets to your children may not be tax efficient," says Heafford. "Whereas leaving assets to a spouse is tax exempt."
Descendants can potentially inherit assets worth up to £1m from their married parents IHT-free via the nil rate band and the residence nil rate band – an extra £175,000 that can be passed on tax-free against the value of the family home. For any assets above this, IHT of 40 per cent is due. The residence nil rate band is only available if you leave your property to direct descendents and for larger estates worth over £2m – maybe like Daniel Craig’s –- these reliefs are tapered away.
However, money remaining in your pension fund when you die is normally free of IHT, unlike most other savings and investments, so should be the last thing you spend.
If cutting out your children completely is too drastic, you can resolve this in other ways. “Avoid your children counting the days until your death by making gifts during your lifetime,” says Sarah Coles, personal finance analyst at Hargreaves Lansdown. “You get to see them make the most of the gift and there can be tax benefits."
You can give up to £3,000 away each tax year IHT-free immediately and, if you haven't used the previous year’s allowance, carry this forwards one year so up to £6,000. You can give gifts for marriage to your child of up to £5,000, your grandchild of up to £2,500 and anyone else of up to £1,000. And you can make unlimited gifts from your income, provided they are regular and don’t impact your normal standard of living.
Shares in a family business, farm, or other investments that qualify for business property relief, such as shares listed on Aim, can be given away IHT-free after you have owned them for two years. With most other gifts, you need to survive for seven years after giving them for them to be IHT free.
Give in the right order
When making gifts that are potentially exempt and chargeable lifetime gifts to a discretionary trust, you should make the discretionary gift first. “The order of giving is crucial to avoid an unnecessary tax charge,” warns Kay Ingram, chartered financial planner.
<Box out> Example of order in which to make gifts
George gives £200,000 each to his sons, David and John. He first gives David a cash gift and later on puts £200,000 into a discretionary trust for John and his children, due to concerns about the stability of his marriage. “The first gift is exempt within the nil rate band and will not be taxable even if George dies within seven years,” says Ingram. “The second gift is chargeable at 20 per cent, but the first £125,000 uses up the remaining nil rate band so only £75,000 is taxed at 20 per cent with £15,000 payable now. If the gifts had been made the other way round no tax would have been due."
Parents who give substantial sums to a number of beneficiaries, spread over time, also need to be aware that the IHT nil rate band and other exemptions will be applied in that same order. “This could leave siblings with significantly different net sums,” cautions Ingram. “The last child to receive funds could have no nil rate band left and, if the donor dies within seven years of giving the gift, lose 40 per cent of their inheritance to tax, while their siblings pay no IHT.”
Ideally, gifts should be made simultaneously so that all children get the same outcome. One way to do this is for all beneficiaries to arrange a life policy in trust which pays out 40 per cent of the nil rate band, currently £130,000, if the donor dies within seven years.
In some cases, the loss of the nil rate band can last for longer than seven years, especially where a series of substantial potentially exempt transfers are made, because the nil rate band takes account of all gifts made over a lifetime and on death.
“For example, Jonathan gives £250,000 to each of his three children in 2013, 2015 and 2021”, says Ingram. “When the second gift was made only £75,000 of the nil rate band was available, meaning that the initial gift will increase the eventual tax liability for longer than seven years.”
A simpler option, if the aim of your estate planning is to minimise IHT and disinherit children, is to spend your money and enjoy life.
“Many people feel guilty about wanting to do this but it is your money which you’ve worked hard for,” says Svenja Keller, head of wealth planning at Killik & Co. “It is also good practice to ensure that you have sufficient funds for yourself, now and in the future, before wealth is passed on”.<boxout>
