This week, we’re going to be talking about planning across generations. Most people who have children and grandchildren want to be able to leave them something when they die. Many people are often wary of Inheritance Tax, which thanks to rising house prices now catches more people than ever. How can you effectively pass money down to those you love in an efficient a manner as possible? Stay tuned for more on this…

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Introduction

One American study of family businesses found that only 30% of the businesses make it to generation two and only 3% are still profitable in generation three. When money is passed down, 60% of it is spent by the second generation, and by the end of the third generation, 90% of families have little or nothing of the grandparents’ money left. Fairly worrying stats, I’m sure you’ll agree. So how can you ensure that money is passed down efficiently, and in such a way that it is valued by those receiving it?

What you need to know

1. Money is not a passive force

Money can divide families and cause people to think and do things which they may not otherwise even think of doing. Care should be taken when passing money down generations.

2. Remember that your wishes come first, and tax a distant second, or third.

Many people are paralyzed by IHT concerns when considering passing money down generations. This can lead to spurious decisions influenced by tax planning rather than starting with what they want to happen. It’s important to start with your desires. Write them down and discuss them with your partner. You may want to discuss with your family, but this can be difficult. When your aims are articulated, you can plan around these and weave tax planning in too, but not the other way around.

3. Trusts are powerful, but underused

Not enough people make use of trusts, but they are useful because they can act as a buffer between the donor and the recipient. Trusts create legal boxes with rules as to how the money can be invested, who it is available to and in what circumstances. Yes, they add complexity, but the benefits are almost always worth it, particularly if your affairs are complex, or if you’re fairly wealthy.

We covered the mechanics of trusts in some detail in Session 22. Think of them as tools to get the job done. No matter what your most complex machinations of how you want to pass money down, you can usually achieve your aims with a trust or several trusts.

4. You come first

It’s amazing how many people consider other people first when it comes to the money they have amassed. It’s good to be selfless, but this is a reminder that your money is just that, YOUR MONEY! Your own needs and comfort must come first. Look after number one!

What you need to do

1. Do some planning

Establish how much you are worth. Do a forecast to establish how much, if anything, you can afford to give away while you are still alive. This is technical work – get in touch with me for help with this.

Come up with a timescale for passing money down to your kids. When might your kids or grandchildren need the money? House purchases, university years, weddings. All these are expensive events. Think about when these events might arise on the timeline, and how much you might want to contribute to them.

Part of this planning will include Inheritance Tax calculations on different scenarios, but remember that you should work the taxation around your desired giving, not the other way around. Common sense says you should use all the available allowances for making gifts. These are covered back in Session 9

2. Keep things flexible

Lifetime gifts are probably best made as and when they are needed. The alternative is to give some money now for future benefit. But if you were to give your 18 year old daughter £15,000 towards her wedding one day, what are the chances it will still be there when she does get hitched?!

You could set up investments which are in your name, but notionally for your children or grandchildren. So you could open a General Investment Account on a platform and designate it for your grandchildren, say. The money is yours and you retain control. You don’t even have to give it to them if your grandchildren end up with ‘issues’. The last thing you want is to save over many years only to fund a drug habit.

Remember there may be tax implications of holding money in your name on behalf of your children. Money given away is irrevocable, so bear this in mind and keep things nimble. One way to give money away and retain an element of control is to…

3. Consider a Master or Pilot Trust

Trusts are underused; often due to ignorance. There are two broad types: absolute and discretionary.

Absolute trusts have named beneficiaries, so I would name my daughters, Ellie Matthew and Kate Matthew and that money would belong to them and be taxed as theirs, just held temporarily in the trust until I died or in this case, they became adults.

Discretionary trusts name classes of potential beneficiaries, for example “my children and remoter issue” and are more powerful but can be taxed quite heavily, so you need to be careful. One pilot trust can cover lots of intended gifts and keep things flexible.

You should be the settlor of any trust, with your spouse or partner ideally, plus you should consider a professional trustee to keep things on track. This will cost you of course. There is some admin to do when using a trust: investments need to be reviewed, minutes of meetings need to be kept, but it is all fairly straightforward. You should however get help with this from an adviser and/or a solicitor.

4. Pensions have benefits

One new angle which has only come about since the Autumn Statement 2014 is using pension plans to pass money down the generations. Currently, money paid out to the next generation from a pension fund is taxed at 55% – pretty punitive. After April that all changes.

If you are in drawdown or if your pension is unvested and you die before age 75, lump sums or income paid to the next generation will be tax free.

If you die after age 75, lump sum will be taxed at 45% until April 2016 and from April 2016 onwards will be taxed as the beneficiary’s income when paid out. If a beneficiary takes an income from the pension pot rather than a lump sum, it will be taxed as income.

Similar rules apply if you have bought an annuity with your pension fund, but the practicalities of this are yet to be worked out by the industry. So pensions can be used to move money outside your estate over time. You can pay into a pension pot, and maybe benefit from it yourself if you need to, but the pot can remain untouched and used for the benefit of your family when you are gone.

A major benefit is the tax relief going into a pension. Definitely you should talk to your adviser about working pension giving into your plan

5 – Don’t forget long term care Remember, you come first. If, in later life, you need Long Term Care, gifts made earlier in life might come back to bite you. Understand that wealth gives you choice, and I can’t think of any better way to spend money than on my own comfort in later life.

For those in a position to make significant gifts to our kids during our lifetime, we’ll likely be paying for care ourselves anyway, with no input from the Local Authority. The biggest risk is that your house may need to be sold to pay for care. If you’re in care though, the house is just a big lump of cash tied up. If you want your kids to inherit the house, then you’ll have to make sure you have enough income and cash available to pay for care yourself, leaving the property for them.

Personally I reckon that if you need to move into a home, then you’re not going to be needing the house anytime soon anyway.

Summary

King Solomon warned, “An inheritance quickly gained at the beginning will not be blessed at the end.” – Proverbs 20:21

Planning is the key to passing money to future generation in an orderly manner. You need to hold your wishes, taxation, flexibility and the mechanics of giving all in tension when working out a plan. You also need to keep it as simple as possible to achieve your aims.

Coming back to the start – money is not a passive force. You don’t want your money, given with the best intentions, to break up your family. I can’t overestimate the value of talking about money sooner rather than later with your family.

Many of our clients are first generation business owners who have built great businesses and maybe sold them, amassing large sums. Often the next generation are not involved in the business and maybe don’t appreciate the work that went into getting the money together. Dumping money on children in one lot when you die might not do them any favours. Instead, using a family trust to retain control over the money, even when you have gone, is a great idea in my book.

News and Reviews

Static at to 16 stone, 2 pounds – boo. Back on it now after the Christmas binge.

Massive thanks to Ric Crane who left me a review this week.

Next Session Announcement

Next time I’ll be answering a plea from listener Rachel, who asked for some guidance for freelancers and self employed people. My good friend Annie Shaw will be joining me that show – she’s a legend, and a bit of a force of nature – can’t wait!

If you have a question on this subject, or any other financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/askpete