Yahoo Finance Money Makeover: ‘How do I minimise inheritance tax on my £1m estate?’
Planning your finances in retirement can feel like a perpetual puzzle, with so many unknown factors at play. How long will you live? And will you be healthy enough to enjoy it?
For Paula Goddard, an 82-year-old from Milton Keynes, these two questions are at the front of her mind as she plans the future of her £1m estate. Ms Goddard, who spoke under a pseudonym, wants to pass on her assets to her two children and three grandsons in the most tax-efficient way possible. But she also wants to use her investments to help her meet possible care costs in the future.
Ms Goddard says: “I have a health condition that affects my eyes. I am otherwise fit, but it could mean that I will need to move into a care home within the next 12 to 18 months.
“I have investments in an Isa but it is a bit of a mishmash. I would like to organise it so that it grows steadily, can fund any future care costs and then eventually can be left as an inheritance for my children.”
Ms Goddard’s main sources of income are defined benefit pensions. Her own occupational scheme pays her £10,441 every year but she has also inherited her late husband’s defined benefit pension, which pays £17,056 a year.
“I live comfortably on my pensions so I am not looking to generate an income from my investments,” she says. “My main questions are how to pass on my assets in the most tax-efficient way possible, while making sure I have enough money to fund care costs.”
Ms Goddard owns her home in Milton Keynes, which is valued at about £650,000. She has more than £170,000 in cash spread over Premium Bonds, savings and current accounts. Her stocks and shares portfolio is invested mainly in global stock funds and is worth about £185,000.
Ms Goddard added: “My late husband also set up ‘bare’ trusts for our grandsons, who are aged 26, 21 and 13. The eldest two now live in New Jersey in the US, and might want this cash soon. I contribute £75 each month into these trusts, but I would prefer to give them all a lump sum of £30,000 each.”
Daniel Hough, financial planner at RBC Brewin Dolphin
Ms Goddard has a relatively large estate at just over £1m, between her house, cash and investments. But inheritance should not be too much of a concern.
Assuming her late husband passed all his estate on to her, the vast majority of her assets should fall within the combined nil-rate bands of £325,000 and the “residence nil-rate band”, sometimes called the “family home allowance”, of £175,000, giving her up to £1m to hand down free of inheritance tax.
That said, these allowances are frozen until 2028, so this may need to be revisited if the estate continues to grow.
However, Ms Goddard mentions wanting to pass on money to her grandchildren – this is where inheritance planning could be more of a concern. If she gives large sums to them, this could constitute what is known as “deprivation of assets”.
This is where the taxman thinks you are trying to give away your wealth so that it is not counted as part of your estate and the council can ask for any of it to be clawed back into an estate to fund your care.
For that reason, we would suggest continuing with the £75 a month payments to each of them, which falls just beneath the £3,000 annual gifting allowance, rather than three lump sums of £30,000.
The investments in Ms Goddard’s portfolio feel punchy for someone at her stage of life. Growth funds are typically aimed at younger investors because of their associated risk. Instead, we would recommend a capital or wealth preservation fund, such as the Ruffer Investment Company or Personal Assets Trust – these are both listed funds traded on the stock market.
A final consideration is transferring the cash held in the trust for Ms Goddard’s youngest grandchild into an Isa. While Isas are very tax-efficient, the fact that the grandchild is only 13 means that this would be paid into a Junior Isa account, which has an annual limit of £9,000.
You could pay the current balance in over two tax years, as we are close to the end of the current one, but do bear in mind that your grandchild will be free to access it from the age of 16.
Ian Dyall, head of estate planning at Evelyn Partners
The most tax-efficient way to give money to her three grandchildren will depend on how long Ms Goddard thinks she will live for.
If she makes a one-off gift of £30,000 outright to each grandchild, or into their bare trusts, this could be treated as a “potentially exempt transfer”.
This is when gifts become exempt from inheritance tax if the individual survives for at least another seven years. If Ms Goddard lives for seven years after making the gift, it will reduce her estate by £90,000 for inheritance tax purposes.
The regular gifts she is currently making may be effective in reducing her IHT liability from the day they are made. Regular gifts may be covered by the “normal expenditure from income” exemption.
If a person has more income than they need, they can give the excess income away via a series of regular payments which are immediately exempt from IHT. To qualify for the exemption, the gifts must be regular rather than one-off; be made from income not capital; and not decrease her standard of living.
So although the gifts may be smaller, they could be more effective, depending on her expected lifespan.
However, the decision about whether to move the money into cash for the two older grandchildren is a bit more difficult.
While invested in funds their value will fluctuate, so a move to cash may preserve the gains made, or may mean missing out on any increases.
However, an important consideration in this case is that the grandchildren are resident in the United States, which means they will be potentially liable to American taxes on their investment returns.
US tax legislation can be quite punitive on collective investments held overseas. As they are adults, and are likely to want the money soon, it may make sense to move the investments to cash and hand it to them now.
