Parents: Hold on to your purse strings
Passing on your wealth to your children before you die may seem like a good idea, but there are risks, warns Chiara Cavaglieri
Sunday 04 April 2010
It seems few young people today can afford to make their way in the world without a little help from mum and dad.
Take purchasing a property, for instance. With lenders requiring hefty deposits, and tightening lending criteria, many first-timers would not be able to make the step without a tidy sum from mum and dad. Many of the baby-boomer generation have found themselves property rich, and new research shows that many parents are opting to swap more traditional inheritance with "pre-inheritance", by passing on part of their estate before they die.
This type of generosity may well be a virtue and the property market certainly relies on the stimulus from such handouts, but are parents leaving themselves open to financial hardship?
"Overall, I guess, the parent in a position to help their adult children is going to do as best they can for them," says Nick Bamford from the independent financial adviser (IFA) Informed Choice. "But they need also to consider their own financial security."
A new study from Aviva, the insurance giant, shows that nearly half of British adults have received a pre-inheritance, compared with only 37 per cent who have received the more traditional inheritance. The most common age group to receive this is 18 to 25 years old, followed by those in the 31 to 40 age group. These age groups represent prime expense periods, with university bills and debt, first homes and the costs of starting their own families.
But the global recession has shown just how quickly things can go wrong, and what may seem like an affordable gift now could damage the retirement ambitions of the parents later on. This is particularly pertinent for anyone relying on their pensions to fund their retirements – for example, if the underlying investments shrink when it comes time to take an annuity.
Another important issue is how this pre-inheritance is spent. Most parents would like the assurance of their money being spent on providing for their children's futures, whether through education, buying their first homes or getting married, but once the money is out of their hands, in theory, they have little say in how it is used.
"Remember that once a gift is made, it isn't your money any more. You have no control over how it is spent or invested," says Jason Witcombe from IFA Evolve Financial Planning.
Where it might end up poses a similar problem, particularly with divorce and second families being so common. If the recipient of a gift is married but subsequently divorces, that money form parts of the marital assets for divorce purposes.
"It may not have been your intention that half of the gift ends up in your child's ex-spouse's hands. This is one reason why some people like to make large gifts via trusts, in order to retain control over who the eventual beneficiaries might be," says Mr Witcombe.
As well as these potential pitfalls, inheritance tax (IHT) can also be an issue. Any large, outright gifts are treated as Potentially Exempt Transfers (PETs) which means that there could be a liability to IHT if you die within seven years of making the gift.
If you give away money and survive more than seven years, the full value of that PET falls outside your estate for tax purposes and, after three years, taper relief reduces the IHT payable, but otherwise it could be liable for the full 40 per cent tax charge.
Therefore, if you are confident that you could manage both now and later down the line without all your assets, and want to reduce the value of your estate and help loved ones, you should make gifts as soon as possible to begin that seven-year clock. "The gift also needs to be without reservation – if the parent is saying 'here is some money but I want it back', it's not a gift in any sense of the word. A loan does not reduce the value of the donor's estate," says Mr Bamford.
The good news is that advisers say careful financial planning should ensure that IHT liability is reduced or potentially eliminated entirely.
Working out your current liability is a priority. IHT is only payable if the value of your estate exceeds the nil rate band for that tax year. It currently stands at £325,000 for both this and the next tax year, and any assets above this amount are taxed at 40 per cent. So, an estate worth £1m would attract a bill of £270,000.
Additionally, since 2007, married couples can benefit from any unused allowance when one partner dies. This would mean that the surviving partner could have an estate worth up to £650,000 – two times the current nil rate band – without having to pay tax.
Once you've worked out your estate value, it's time to consider making the most of your gift allowances. First, capital gifts of up to £3,000 per year can be made without incurring inheritance tax. This allowance can also be carried forward for one year. Then, any number of small gifts, up to £250 per year, can be given to any number of recipients, plus gifts of £5,000 to a child and £2,500 to a grandchild as a wedding present.
One of the most effective ways to use these allowances is to set up regular annual savings for your children or grandchildren, so £3,000 could be paid into an ISA or a stakeholder pension.
Finally, any gifts out of income, not capital, that are "regular and habitual" are also free of IHT, so it is possible to start drawing income from investments that are currently accumulating, then give this income as surplus.
"One often-overlooked allowance is regular gifts out of normal expenditure," says Kevin Tooze from IFA Equity Partners UK. "These are allowed if they do not affect the donor's standard of living, and can build into large sums."
Cash generation: My mum and dad helped me buy my own flat
Faye Williamson, 24, a PR consultant, says that without the help of her parents, her dream of getting on to the property ladder would have remained a distant possibility.
"Mortgage deals are so hard to come by. I had been renting in London for about five years and, even though I loved living with friends, I was looking for my own place," she says.
Faye found a one-bed, new-build flat worth £215,000 in Kennington, south London, but didn't have enough savings for the deposit. So, in January of this year, her mum and dad helped out with £8,000, and she was in her new home by February.
"Mum got a shock," said Faye, "as she initially thought she was only going to be buying me a sofa bed."
Faye's parents, Bill, 59, and Barbara, 57, live in Liverpool and work in colleges. She says: "It was a generous gesture, but they like to remind me that I'll have to pay their fees when they're old and in a home."
How to cut Inheritance Tax
* Donations of any size to registered UK charities, political parties and for national purposes (such as the National Gallery) are exempt from Inheritance Tax (IHT).
*£3,000 can be given away each year tax free, using the annual tax-free allowance.
*Small gifts of up to £250 can be given, tax free, to an unlimited number of people.
*Wedding or civil partnership gifts of £5,000 from parents, £2,500 from grandparents, and £1,000 from other benefactors, are exempt from IHT.
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
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