How can we leave assets to our children without incurring excessive IHT?

Rob and his wife are aged 72 and 73, and have been retired since they were 60. They receive former workplace defined benefit pensions, an additional voluntary contribution and state pensions. These give them an income of £50,000 a year after tax on which they live comfortably. They fund expenses such as travel from their pensions income and occasionally by taking profits on investments in their individual savings accounts (Isas).

They have two children aged 47 and 45, and four grandchildren between the ages of five and 10.

Their home is worth about £550,000 and mortgage free.

“We hope to avoid excessive care costs in later life as our aim is to leave assets to our descendants without excessive inheritance tax (IHT) liabilities,” says Rob. “But we wondered what our children should do with the assets that we pass onto them after our deaths. They work in education; and the younger earns about the UK median salary of £32,000 a year and the other earns more. We have already given them both significant sums of money as deposits to buy homes and make further gifts to them when they want to make major home improvements.

"We thought that ways our children could use the wealth they will receive include having fun with 5 per cent to 10 per cent of it, setting aside 5 per cent as an emergency cash fund and holding 25 per cent of it in an Isa to fund holidays. They could also use it for home improvements, family medical and dental insurance, a holiday home or holiday property bond, cars, and fully using their annual Isa allowances. Another option would be to use the money we pass onto them to maximise annual pension contributions, maybe contributing to their workplace schemes, though I think they would be better off putting it into self invested personal pensions (Sipps).

Or they could gift the money they receive to their children by putting it into Isas or Sipps for them, or buying them properties.

"We will also stress that they should not lose the value of their inheritances to inflation or squander them.

"We also contribute to junior Isas for our four grandchildren. As post-war babies, our parents made us very aware of debt problems, so we hope that these junior Isas will enable our grandchildren to go to university or start a business without taking on debt. We also hope that each of our grandchildren will have a deposit to buy a home. So in 2016, we set up a small discretionary trust to fund these and it now has a value of about £207,000.

"We manage our own Isas and grandchildren’s investment accounts which are invested in funds at the more adventurous end of the risk scale. I would hate for the value of our investments to fall by more than 20 per cent but the capital invested is surplus to our financial needs so I take risks. And as the investments are for the longer term benefit of our children and grandchildren we can take a long view.

"We started investing when BT (BT.A) was privatised in 1984 and have made very good returns at times during the past three decades, though have also had a few poor years. A friend has described my investment approach as ‘greedy and impatient,’ and I think I trade too often. Recent trades include selling Fidelity China Special Situations (FCSS), FSSA Greater China Growth (GB0033874321) and JOHCM UK Dynamic (GB00BDZRJ101), and some of our holding in Baillie Gifford American (GB0006061963). And I have added Mobius Investment Trust (MMIT) and Vietnam Enterprise Investments (VEIL). I rebalanced our portfolios at the end of last year."

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.

Chris Dillow, Investors' Chronicle's economist, says:

You are taking the long view because you are investing for your children and grandchildren. But why should the long term view be different to the short term one?

Like many investors, you consider that long-term investing involves holding funds invested in countries or sectors likely to produce long-term growth, such as biotech, technology and some emerging markets. But this is questionable. The work of Jay Ritter, professor of finance at the University of Florida, and MSCI economists has shown that in the long-run there is no correlation across countries between growth and returns. In the past 10 years, for example, China’s fast growing economy has delivered worse returns for equity investors than the slower-growing economies of many European countries such as France, Switzerland or the Netherlands.

A reason for this is because investors anticipate growth and price it into shares in advance, meaning that only unexpected growth boosts share prices. So if growth dips below expectations, equities suffer.

This is especially worrying because longer-term corporate growth is almost impossible to forecast. Louis Chan, professor of business at the University of Illinois, and Jason Karceski, portfolio manager and Josef Lakonishok, chief executive officer, at LSV Asset Management, have found that there is “low predictability” in long-term earnings growth. And Alex Coad, professor at Waseda Business School, and late economist and academic Paul Geroski said that corporate growth is largely random.

So betting on long-term growth is risky - you might be buying expensive stocks that don’t deliver the hoped-for returns. For example, in the past few weeks Netflix (US:NFLX), Peloton (US:PTON) and Meta Platforms (US:FB) have experienced big share price falls - a warning of what can happen when growth falls short of hopes.

You could argue that as a long-term investor you can look through short-term earnings disappointments. But disappointments are not necessarily confined to the short-term. Japanese stocks are still lower than they were in 1989 and the FTSE Aim index is lower than it was in 1999. This warns that betting on growth can lead to decades of losses.

The solution to this is to hold a global equities tracker fund which diversifies risk. This is also a type of momentum fund because as shares out perform the market it increases its weighting in them, and as they under perform its weighting to them decreases. So a global equities tracker backs growth stocks without falling into the error that growth investors often make, of holding onto falling stocks. And, insofar as a tracker fund is likely to deliver real returns over the longer term, it protects you from longer-term inflation.

Also consider holding a private equity investment trust or two. It’s possible that a disproportionate amount of future growth will come from companies that are not yet listed on public markets. And private equity and venture capital funds give you exposure to these.

With regard to your descendants, I’d stress two conflicting things which need balancing. The value of freedom, such as the possibility of early retirement, is valuable and you need savings to achieve this. And good investments are not necessarily financial: holidays and spending on experiences are a form of investment as they give us happy memories for later in life. George Best had a point when he said: “I spent a lot of money on booze, birds and fast cars. The rest I just squandered.”

Colin Low, managing director of Kingsfleet Wealth, says:

When looking to mitigate potential IHT, remember that the £3,000 individual gift allowance can be paid into a trust - £6,000 if both you and your wife contribute. This could be a way to create a second discretionary trust which you could build up over time. Contributions out of surplus income are also exempt from IHT. The combination of your annual gift allowances and surplus income could enable you to rapidly build up a second discretionary trust. But be aware of potential periodic (10 year) and exit charges which apply to discretionary trusts.

To increase the level of income which could be provided, you could take the dividends from your Isas, which are tax free, and also put them into a second trust. 

Isas are subject to IHT unless they are invested in exempt assets such as qualifying Aim shares. There are a number of asset managers who run portfolios of Aim stocks which qualify. The IHT exemption for certain Aim shares takes effect after you have held them for two years.

While your grandchildren are young, there is no issue with the level of risk you are taking with the investments in the Junior Isas. However, as they approach age 18, you should monitor this level of risk because if they need to draw from the Isas at that time you would not want to expose them to undue risk. The Junior Isas should grow to be quite significant funds and it would be a shame if a market correction reduced their value as your grandchildren's eighteenth birthdays approach. 

Gifts into Junior Isas also count towards your annual gifting allowance for IHT purposes.

When giving your children guidance on how to allocate assets they will receive after your death, I suggest documenting the way in which you would like them to spend or invest the money. And explain why you think this is important.

You could also record a video detailing how you invest and why this method has worked for you. And you could explain any lessons that you have learned from this process and ways in which you could have done it better. This would give your beneficiaries a sense of the things that have been important to you and might assist them in making their own decisions when the assets are theirs to spend or save.

George Steger, senior wealth manager at Investment Quorum, says:

Your main aspiration is to build up assets, and leave them to your children and grandchildren as tax-efficiently as possible. Perhaps the simplest method of passing on wealth is outright gifting. These gifts are treated as potentially exempt transfers and deemed to be outside your estate after seven years. But you have no control over the assets when they have been given so cannot dictate how they are used.

Gifts from surplus income fall outside your estate immediately as long as the gift is part of your regular expenditure and made from net income, and you still have sufficient income to maintain your current standard of living.

Discuss the rationale behind your gifting with your children. And when your grandchildren are older, also explain to them the thinking behind your gifts and how to sensibly use the family wealth.

Your investments reflect your high risk mindset. However, you have a decent cash allocation which will allow you to book cost average or take advantage of volatility. You don't want your investments' value to fall by 20 per cent or more. So, for example, what is your approach with iShares Global Clean Energy UCITS ETF (INRG) which has endured a rollercoaster ride since 2020? 

You say that you are impatient but, given your long-term investment time horizon, a little patience may be beneficial as timing is very difficult to consistently get right. And selling and buying less does not mean you have to give up your high-risk approach. 

Your investments have a growth style bias so may have had a difficult few months. But as you have a high risk, long term investment profile this should be acceptable to you. And the investments are well diversified geographically.

Although you want to maintain your growth focus, consider a couple of income generating holdings to provide a bit of ballast. You could do this without churning your investments to the extent that they become a value portfolio because of near term momentum. Dividends are anticipated to have a bumper year as increases in pay-outs are expected to continue, following a tricky period in the midst of the pandemic.

Ways to get such exposure include Liontrust Global Dividend (GB00B9225P64). The fund's mangers, Storm Uru and James Dowey, target a growing dividend from companies they view as global leaders. The fund doesn't have a style bias, though they like innovative businesses and stick to the approach that many of the funds you already hold also take. But - importantly - Liontrust Global Dividend's managers target companies with durable business models that should be able to weather unknown future events.

Alternatively, SPDR S&P US Consumer Staples Select Sector UCITS ETF (SXLP) is an easy and cost efficient way to add some defensive exposure to complement your growth focused portfolio. This exchange traded fund (ETF) tracks large US consumer staples companies, and provides exposure to ones which are typically characterised by steadiness because they have consistent earnings, low volatility and decent yields.

Consider increasing the number of asset managers the Junior Isas have exposure to as just two run a large proportion of the funds within these. We appreciate the long term nature of the funds but you should widen the opportunity set, even if you maintain the growth slant.