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Pass it on: how to help the children in your life financially
Coronavirus (COVID-19) has focused a lot of people’s minds on the future. If you’re planning to leave a financial legacy to the children in your life, it can be far more effective to start planning now. Ian Dyall, head of estate planning, Tilney Financial Planning Limited, explains your options
Looking at the changes that have occurred over the last 30 years since I started my career, it’s clear that younger generations are facing financial headwinds that I never had to.
They need to pay off their university debt, while at the same time try to save a deposit for a first home. At work, they are likely to have a far less generous pension than the final salary scheme that was funded for me for many years.
At Tilney, we are seeing an ever-increasing number of clients who wish to help the children in their lives – be that offspring, nieces or nephews, godchildren or family friends – financially. What’s the best way to do this?
There are five factors which need to be considered when giving away your money:
- tax efficiency
- protection of the money being gifted
- when the money needs to be available to the recipient
- the extent of any control that the donor wishes to retain
Make an outright gift
The simplest way to pass on your money is to make outright gifts to the child, but there are downsides to this.
As the donor has no control over how the money is used, it can be tempting to put off gifting until the child is ‘mature enough’ or in a stable relationship. But young people need the money far more when they are starting out or bringing up a family than when they are older.
Making gifts on a regular basis rather than gifting a lump sum can help mitigate some of the risk, as the payments can be stopped if necessary. If the payments are made regularly from excess income, then they may be immediately exempt for inheritance tax (IHT) purposes.
Invest in an ISA
Another option is to fund investments on behalf of the child. ISAs can be particularly attractive, as they grow free of income tax and capital gains tax (CGT).
There are several types of ISA available.
These are available to minor children. They have the advantage that the money can be rolled into a standard ISA at age 18 without CGT.
A junior ISA must be set up by the child’s parent or guardian, but anyone can contribute to it. If it is funded by the child’s parents, the ISA will avoid the parental settlement legislation, whereby if a parent gifts to a minor child, any income is taxed against the parent if the income is over £100.
Unfortunately, you can only invest up to £9,000 per tax year into a junior ISA and the money cannot be used before the child reaches 18, even if it’s for their own benefit.
Adults can invest up to £20,000 into a standard ISA each tax year. Contributing money into a pension is perhaps more tax-efficient, but ISAs can be accessed at any age should the investor need the money, unlike a pension which can only be drawn on from the age of 55.
A tax-efficient middle ground may be a lifetime ISA. Adults aged between 18 and 39 can invest up to £4,000 of their £20,000 ISA allowance into a lifetime ISA and the government will add 25% (which is similar to basic rate relief on a pension).
There is a 25% exit penalty if the money is withdrawn, unless:
- it’s used to buy a first home (a property worth up to £450,000 which is purchased at least 12 months after initially investing into the lifetime ISA), or
- the investor is over 60 years old
In effect, this claws back the bonus provided by the government.
While you cannot contribute directly into an adult child’s ISA or lifetime ISA (you would need to gift them the money and they would need to make the contribution themselves), the combination of a lifetime ISA and an ISA provides a tax-efficient way to save for a deposit on a first home and at the same time build an emergency fund that can be accessed in tougher times.
Bear in mind all ISAs would be vulnerable to creditors, or if the investor got divorced.
Note that ISAs and pensions are forms of investments and you may get back less than you invest.
Set up a trust
If you are looking to gift to a minor child who is not your own, then a bare trust (or a nominee account) could provide more flexibility than a junior ISA and be equally tax-efficient, provided the annual income and gains are within the child’s annual tax allowances. This is because the parental settlement rules only apply to parents, so the child’s allowances can be used.
Under an absolute or bare trust, the trustees are the legal owners of the assets but the beneficiaries are ‘absolutely’ entitled to them. This means that the money within bare trusts can be demanded by the child at the age of 18 and, once a bare trust has been set up, the beneficiaries cannot be changed.
Most donors are concerned about providing access to too much money at this age, so we often recommend a combination of a bare trust and a discretionary trust.
A donor invests a sum of money into a bare trust to make use of the child’s allowances. This money can be accessed for the child’s benefit before they reach 18, if necessary. A larger sum is invested in a discretionary trust, which can be held beyond the age of 18 for the benefit of the child in later life.
As the name suggests, discretionary trusts give the trustees discretion over when the money is received. The trust provides protection if the beneficiary becomes divorced or bankrupt but is less tax-efficient than the bare trust, as the child’s allowances can’t be used.
The real advantage of a discretionary trust is that multiple beneficiaries can be named. Building up a sum of money that can be used to support multiple generations, should any of them need support, could give many people the peace of mind that their financial wellbeing is secure.
Children can have pensions too. As with a junior ISA, the pension should be opened by a parent or guardian, but anyone can contribute to the pension on behalf of the child. A maximum of £2,880 can be paid into a child’s pension each year.
This way of gifting money is attractive due to the basic rate relief available, even to non-taxpayers. In effect, every £1 invested is topped up to £1.25 by the government. But you need to bear in mind that the money cannot be accessed until the child reaches retirement age.
Your own pension can be an extremely useful tool for passing on your money on your death.
If you have a money purchase pension fund that you do not need for your retirement, preserving it and passing it to your nominated beneficiaries can be a very efficient way of helping future generations. It can be passed on free from IHT and the beneficiaries can draw from it at any age. They will only pay income tax on the money they withdraw at their own marginal rate (or without any income tax, if you die before the age of 75).
Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change.
The best solution for most families is usually a combination of the options above.
With careful planning, fears about whether the gifts are affordable or how the money is used can be largely mitigated. You also get the benefit of seeing how your support has helped the children in your life.
Talk to Tilney
Tilney is a strategic partner of the Law Society.
Tilney’s experts are on hand to help answer any questions you may have about passing on your money and discuss the best options for you and the children in your life. To find out more, book an initial, free-of-charge consultation online or call 020 7189 2400.
The value of an investment may go down as well as up, and you may get back less than you originally invested.
Issued by Tilney Financial Planning Limited, authorised and regulated by the Financial Conduct Authority. Registered in England and Wales, No. 00607039 FRN: 136414.
Advice in relation to trusts is not regulated by the Financial Conduct Authority, however, the products used in relation to trusts may be regulated.