The intergenerational transfer of wealth is a topic of passionate debate. Hugely diverse opinions depend on the age of benefactor, the age of future beneficiaries and their financial acumen, and family stability.
By Lynne Rowland and Guy Sterling, Tax Partners at Moore Kingston Smith.
Some familiar themes
- Parents and grandparents want the best for their families. This could mean providing financial resources for children and grandchildren to be educated at a top public school, or to support a talent in the arts or a sporting environment that may not generate significant income.
- Entrepreneurs who build their own wealth often see themselves as role models and want their children to follow in their footsteps. They may provide seed capital to enable the next generation to start their own business.
- Families who inherit substantial wealth or who are beneficiaries of trust funds often see themselves as custodians rather than owners of assets. They have a relatively limited ability to dictate what happens to those family assets. There may be a family office with an advisory board of external advisers that oversees proceedings.
Some benefactors choose a mixture of giving financial support to their children, making generous gifts to charity and undertaking tax planning to ensure that the family pays their fair share of tax. They usually take advice to ensure that they take advantage of reliefs, exemptions and making gifts tax-efficiently. This approach usually involves a transfer of assets to the next generation to reduce inheritance tax. The important questions are when the transfer should happen, how much should be gifted and to whom.
When, how much and to whom?
The first thing priority is to have an honest conversation with one’s family about intentions and how they could be affected. Receiving wealth is not always welcomed and could be regarded as a burden. Wealth education is key to succession.
It is a good idea for benefactors to take the emotion out of the conversation by preparing a personal balance sheet to evaluate their capital and income position and thus to project future needs. A strategy to pass any surplus to the next generation can be more sensibly made following that exercise.
Senior family members with surplus income have more flexibility than those who are gifting capital. Documenting the gifts made and ensuring that no benefit or control is retained is essential.
It is never too early to start planning, although if the beneficiaries are not adults there are additional considerations. Gifting to young adults who are not deemed mature enough to deal with wealth can create issues and family discord. They may not have found their life partner and there is usually some concern about relationship breakdown, and fear of family wealth being used to fund a failed relationship. This explains why trusts are often a favoured vehicle.
Once benefactors have decided what can be given away there is the dilemma about whether to make direct gifts to beneficiaries or transfer into trust. Capital gains tax as well as inheritance tax needs to be considered.
The decision is often dictated by family circumstances and the nature of the assets to be gifted. For instance, if there is a family trading business those shares can often be transferred free of an immediate tax charge. Transferring into trust to keep the family business under control is often a preferred route. Other types of assets can be more difficult to transfer into trust and could incur a lifetime tax charge when the value exceeds the available nil rate band.
The Tax Angle
For inheritance tax purposes, if there is benefit from assets benefactors have transferred into trust those assets may be regarded as remaining in their estate. Ideally benefactors should ensure that they and their spouse are excluded from benefit. A benefactor appointing himself as trustee will not have any adverse tax implications.
Gifting assets to an individual should be a potentially exempt transfer for inheritance tax. In such circumstances, the transfer of assets will be free of inheritance tax if the giver survives seven years from the date of the gift. If three years have elapsed following the transfer, an element of taper will be available to reduce the tax exposure.
From a trust perspective, the death of a beneficiary is not usually a taxable event although the trust is taxed on the net value of its assets every ten years, at a maximum rate of 6%. This rate depends on the charge at entry or at the previous ten-year anniversary and compares favourably with the 40% tax that can be levied on assets held directly at death. As the anniversary date is known it is possible to plan to mitigate the burden of the anniversary charges.
Another alternative is creating a family investment company. Family members can be invited to subscribe for shares in advance of making loans of cash that can be used to invest and diversify the family asset base. This can be a more flexible strategy than using trusts, but from an asset protection perspective trusts are probably a preferred vehicle.
If assets are tied up, or where the ownership structure will make transfer difficult, taking out insurance to fund a future inheritance tax liability may be the simplest option.
It is vital not to leave heirs with a financial legacy that is not documented or understood. Equally important of course to take professional advice, listen and converse with one’s family, formulate a plan and action it. The strategy for giving should be reviewed every five years or following a life event to ensure that it remains relevant. Any changes should be reflected in the benefactor’s Will and Letter of Wishes.
Lynne Rowland and Guy Sterling, Tax Partners at Moore Kingston Smith
This article was first published on eprivateclient.
This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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