Guide to passing on wealth before you die
Passing on wealth to the next generation has long been the desire of those who have accumulated assets during their lifetime, but given the cost of housing and the challenges many people find with daily living expenses, this transfer has become all the more important.
Many grandparents are aware that their children, and especially their grandchildren, may not find it so easy to build wealth over their lifetimes, so there are tools available to donors to help make that easier.
These could be opening a pension – for a grandchild for example – or a savings account, or simply by making a gift. But all these transactions come with caveats, so donors must ensure they are making the right transaction.
Financial advice is important in these circumstances, and by engaging with the next generation, financial advisers also open up the door to securing the next pipeline of clients.
This guide is worth an indicative 60 minutes' CPD.
Building a nest egg
Shrewd grandparents can build a generous nest egg for their grandchildren by paying into a junior pension from the moment they are born.
It is no secret that many grandparents relish the opportunity to put money into their grandchildren’s Junior Isa to help them pay for their first home or car. But some are now choosing to pass on their wealth through a junior pension.
Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, says contributing into a junior pension for a child is a useful, if underused, way of giving loved ones a real uplift with their financial planning.
She says: “Giving grandchildren an early boost to their retirement planning brings them more flexibility when it comes to their own financial planning.
“They are less likely to need to make huge contributions of their own and this means they can direct more of their money to other financial goals such as saving for their first home.
“Even putting small amounts aside on a regular basis can really mount up, and by the time they reach 18 they could have tens of thousands of pounds set aside for retirement. This puts them streets ahead of their peers who won’t be auto-enrolled into a pension until they reach the age of 22.”
Putting small amounts aside on a regular basis can really mount up, and by the time they reach 18 they could have tens of thousands of pounds set aside for retirement
Parents must set up the junior pension – however, grandparents can contribute towards it.
A junior pension can be in the form of a standard stakeholder pensions or a Junior Self-Invested Personal Pension. With both options, the annual tax-free contribution allowance is £3,600 and the government will top it up by 20 per cent, up to £720 a year. So that means a maximum contribution will actually only cost grandparents or parents £2,880.
Independent financial adviser Aj Somal says the main difference between the two options is that the fund choice for the Junior Sipp tends to be wider when compared with a stakeholder pension.
However, there is an annual charge cap on a stakeholder pension, whereas a Junior Sipp has no cap.
Somal adds that a standard stakeholder pension is the most commonly used junior pension option, and that this arrangement is mainly used by wealthy grandparents who have large sums of disposable incomes.
He adds that junior pensions do not have as wide a reach as a Jisa because of two major factors – the annual allowance for tax-free contributions and the age at which the money can be accessed.
Currently, the annual tax free limit for a junior pension is £3,600, but for a Jisa the threshold increases to £9,000.
Another factor is that grandchildren can only access a junior pension when they reach 55. This age limit is due to rise to 58, and may climb even higher over the next few decades. However, a Jisa can be accessed when a child reaches 18-years-old. This means it can be used to pay for university fees, a deposit on a house or a car.
Somal, chartered financial planner at Birmingham-based Aurora Financial Planning, said: “Most of my parent and grandparent clients do Jisas for the children. However, l do have a small number that do pensions for their grandchildren.
“With pensions, the grandchild cannot access funds until age 55 at least, due to rise to age 58, and may well be a higher age over the next few decades. So, accessibility by the grandchild is a major disadvantage compared with Jisas.
With pensions, the grandchild cannot access funds until age 55 at least, due to rise to age 58
“The parents and grandparents are restricted to lower contribution amounts with pensions compared to a Jisa, and with platforms, the fund choice between the two options is comparable and so are the ongoing charges.”
Although junior pensions are available, they are still niche. The 2016-2017 official statistics suggest 20,000 people under the age of 16 have a pension in receipt of contributions.
This comes as Aviva recently issued guidance on how grandparents can help save for their grandchildren.
Interestingly, Aviva suggests that grandparents keen to save for the younger generation should prioritise their own financial status first.
Alistair McQueen, Aviva’s head of savings and retirement, said: “A priority must be to secure your own financial needs in retirement. The temptation to put others first could backfire if you’re then forced to call upon their financial support in later life.
“But for those who have already secured their own retirement needs, considering the needs of your children and grandchildren could be a positive, and appreciated, next step.
“Relatively small contributions today could deliver a sizeable gift when they eventually choose to access this money. For example, £50 of saving every month from birth to age 18 could grow in value towards £100,000 by the time the beneficiary reaches age 65. That would be an amazing gift for whom most would be thankful.”
With such a long-term investment horizon, it is possible to follow an adventurous strategy that will hopefully bring greater rewards. However, this is not guaranteed, as the value of investments can go down as well as up, so their grandchild could get back less than what has been invested.
A reservation that some grandparents may have in paying into a junior pension is figuring out how to ensure their generous financial gift is not wasted. Some may also worry that their grandchildren may become complacent from gaining vast amounts of money sooner than others their age.
However, chartered financial planner Kusal Ariyawansa says this provides many advisers with an opportunity for intergenerational planning.
Ariyawansa, from Appleton Gerrard Private Wealth Management, says: “This is a wonderful opportunity for intergenerational planners to explain the value of savings, compounding interest and responsibilities – enabling each generation to progress faster than that previous.
This is a wonderful opportunity for intergenerational planners to explain the value of savings, compounding interest and responsibilities
“The investment gives the donee options and, more importantly, a reduction in financial stress, knowing they have a head start compared to most others. For the donor they get to reduce the value of their estate, make meaningful contributions and see its impact whilst maintaining a degree of control.”
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The advantages of protection
Older generations are funding income protection policies for their adult children in a bid to maintain their own financial goals, according to protection guru Kathryn Knowles.
Knowles says smart older people are protecting their own finances from being depleted if their adult children are unable to work by paying for their offspring’s protection policies. This includes polices such as family income benefit and critical illness.
This is because many older generations are likely to dip into their own savings to help keep their kids afloat if they are unable to work and therefore struggle to pay their bills and mortgage.
Knowles, managing director and co-founder of Cura Financial Services, says: “Many of us know about the benefits of gifting and inheritance tax planning already, but there are other areas too where older generations can help their adult children financially. One of the suggestions is that the older generation potentially help to pay towards an income protection policy for their children.”
Paying for an income protection policy for a child, who is over 18, might just help the parents to maintain their own financial goals
The managing director of broker Cura Insurance, adds: “If the children are ill and can’t work then it’s likely the parents will eat into their own money to keep their kids afloat. It may not suit everyone, but paying for an income protection policy for a child, who is over 18, might just help the parents to maintain their own financial goals.”
Protection policies are increasingly being seen as a favourable option to help look after families if they run into trouble.
This is because many income protection policies are often paid out monthly rather than as one big lump sum, which removes the recipient’s impulse to waste the funds on unnecessary items.
Sean Dunlop, protection proposition manager at Scottish Widows, says this is one of the advantages of protection policies. He says: “Unlike mortgage protection where there is a clear need for a lump sum to pay off the outstanding lending, family protection rarely requires a significant lump sum to cope with the loss of a key earner.
“Lump sum payments are likely to give a grieving family a challenge in budgeting and ensuring that the large windfall they have received will last as long as they need it to.
“Receiving the benefits on a monthly basis removes the impulse to blow the funds on unnecessary items and ensures that the household-running expenditures the policy was set up to cover continue to be paid.”
Interestingly, IFA Keith Churchouse has revealed he has also seen a rise in older generations stepping in to make contributions towards their children’s pensions and protection policies – especially during the current cost-of-living crisis.
This is because contributions towards such policies are the first thing to be reduced in a time of crisis, and although this alleviates financial pressures in the short term, it can have a devastating effect in the long term.
He said: “Many refer to the great ‘wealth transfer’ to younger generations. We have not seen a significant level of this cascading; however, we have seen many more parents and grandparents helping the younger generations with the monthly bills and costs to make sure they make ends meet. This is likely to become more significant after October when the Ofgem price cap rises significantly.
We have seen many more parents and grandparents helping the younger generations with the monthly bills and costs to make sure they make ends meet
“Many households reviewing their budgets are seeking to make savings, and this can include cutting back on pension contributions and reviewing protection costs. Both usually a bad idea in the long run. Many older generations will know this and will step in to help make sure that everything is maintained for the longer term, rather than short term gain.”
Churchouse, director and chartered financial planner at Chapters Financial, adds: “Perhaps the message here is for families to talk about money to make sure that help is used effectively where available.”
This shift in older generations using their money to plug any financial gaps for their adult children is a sign of how parental responsibility and attitudes have changed from a few generations ago, according to IFA Gemma Siddle.
The chartered financial planner at Eldon Financial Planning, says: “The change in attitudes through the generations is increasingly evident, with this being a clear example. A generation or two ago, many parents would typically see their financial duty to their children ending when they move into full-time work, whereas as time progresses this is increasingly changing to more of a lifetime and lifestyle integration of family money.
“Policies such as this can provide protection. but it’s important to consider the ownership, the beneficiary, and the treatment of the premium on protection policies from all perspectives; purpose of the plan, likely use of funds and control over these, and for inheritance tax purposes too.”
Despite the eagerness of many older generations wanting to step in to help their adult children, IFA Haresh Raghwani says that this may not always be necessary or the right course of action.
Instead, Raghwani says it is more important that an adviser accesses a client’s actual needs before setting up any protection policies. This is because, he says, most financially independent adults will more likely need help to pay an inheritance tax bill.
The director and chartered financial planner at Craufurd Hale Wealth, says: “With any type of protection advice, a good adviser needs to clarify with a client that an actual need exists. Most older clients will have children who are financially independent and therefore potentially require assistance with paying an IHT bill.”
The pitfalls of inheritance tax
Older generations must consider their life expectancy before making a gift to their children, or risk burdening them with huge inheritance fees, an expert financial planner has warned.
Mel Kenny, chartered financial planner at Radcliffe & Newlands, says making gifts to children may not be as straightforward as it sounds and could have serious inheritance tax implications if the donor is older, because a gift is only exempt from IHT if the benefactor lives more than seven years after transferring it.
Kenny says: “Older people considering making lifetime gifts need to have one eye on average life expectancy and the implications of a failed gift when it comes to inheritance tax.
Older people considering making lifetime gifts need to have one eye on average life expectancy and the implications of a failed gift when it comes to inheritance tax
“If the donor of a large gift made to another individual does not survive seven years, then there could be IHT implications. The first £325,000 of the failed potentially exempt transfer would typically take up the nil-rate band, which would reduce the net value of the final estate available to beneficiaries of the will. Any part of the gift in excess of the NRB would see tax fall on that element upon the recipient of the gift.”
He argues that in this situation, a gift inter vivos life assurance policy would be handy.
This provides a lump sum to cover the potential IHT liability that could arise if the donor of a gift, who is not covered by the NRB or residence nil-rate band, dies within seven years of making the gift. The policies would be written under trust for the recipients of the gift to enable them to pay the IHT due on the gift if the life assured were to die during the term of the plan.
Kenny adds: “A gift inter vivos policy, which is a form of decreasing term assurance policy lasting seven years, would help the recipient of the failed gift. A separate seven year level term assurance policy in trust to the beneficiaries of the final estate should be considered alongside this too.”
This was echoed by Chris Dunne, protection proposition manager at Scottish Widows, who says those thinking about gifting need to be aware of IHT and consider gift inter vivos.
He says: “If a client makes a gift to another person while they are alive and, assuming there is no exemption, this gift could potentially be subject to IHT for the next seven years.
“A gift inter vivos life assurance plan allows you to set up individual policies which collectively aim to provide a lump sum to cover the potential IHT liability that could arise for the person who has received the gift, if the donor of a gift dies within seven years of making the gift.”
Another tip that older generations should take into account is to make their gift to a loved one as early as possible.
Craufurd Hale Wealth's Raghwani, says: “The earlier a donor can start making gifts the better. However, the donor needs to consider if they can make gifts now without impacting their standard of living, or will these gifts happen on their death.
“It maybe wise to use the IHT exemptions already available, like the annual exemption allowance, or small gifts allowance, or gifts on marriage.
It maybe wise to use the IHT exemptions already available, like the annual exemption allowance, or small gifts allowance, or gifts on marriage
“If gifting property, for example, this becomes more complex, and then both financial and tax advice would be required. The donor needs to be careful that they do not fall foul of the gift with reservation rules.”
However, Scott Gallacher, director at Rowley Turton, says that although it is important to factor in any IHT implications, this is not something that everyone needs to worry about, as many gifts and estates are under the threshold.
Gallacher, says: “Many people worry about IHT unnecessarily. We receive many calls from people worried about IHT but with estates below their NRB and RNRB levels.
“Gifts of up to £3,000 per tax year per donor are exempt from IHT. So, anyone can gift up to £3,000 per tax year with no IHT concerns at all. You can also use last tax year's exemption if you didn't utilise that. So up to £6,000 can be exempt. In addition, gifts up to £250 per donee per tax year are exempt. So, you could split the £3,000 between your kids and gift an additional £250 to each of your grandchildren, all of your friends, anyone, and that's exempt.
“Regular gifts out of excess income are also exempt. So, if your income is say £40,000 a year but your normal expenditure is only £30,000 then you can gift up to £10,000 per annum which is exempt. It's important that these gifts are regular in nature though. One-off gifts are not exempt under this exemption.”
However, he adds that although gift inter vivos policies can be helpful, they are often misused. Instead, he recommends a level term assurance policy.
He said: “Unfortunately, gift inter vivos policies are often used incorrectly by people not fully understanding the IHT and taper rules. PETs are often not actually taxed, even if you die within seven years. This is because they normally fall against your NRB. And, if they fall against your NRB, the taper doesn't apply.
“What normally happens is the PET uses up some or all of your NRB and results in more of your remaining estate being taxed. Hence, rather than a gift inter vivos policy, most people require a level term assurance policy instead.”
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Engaging the next generation
Astute advisers can secure the next generation of consumers by setting up protection policies for their current client’s children or grandchildren, according to Setul Mehta, head of business development and adviser services at The Openwork Partnership.
Mehta says this provides advisers with a regular way to engage with the younger generation and secure their business.
“Putting in place protection policies for clients’ children or grandchildren can definitely be a way of securing the next generation.
Putting in place protection policies for clients’ children or grandchildren can be a way of securing the next generation.
“It enables an adviser to regularly communicate and engage with a client; through that engagement, they may be able to support the client with more opportunities such as the first Isa or the first mortgage.
“The key element is not to stop engaging after a single transaction. The door is now open to keep communication going.”
But what are practical ways advisers can entice the younger generation to use their financial planning services?
Interestingly, Mehta says some advisers do reduce their commission to lessen a client’s premium in the hope that this reduction will secure more business from them in the future or through the client referring the adviser to other family members and friends.
He says: “Advisers cannot reduce commission to directly create an investment in their business. Sacrificing commission helps reduce a client’s premium, which then means the income generated on that policy will reduce.
“However, some advisers will reduce their commission to secure a client and that client may in future give them additional business or referrals.”
Commenting on whether advisers can opt for alternatives to indemnity commission to take risk out of the business, Mehta says: “Non-indemnity commission, often known as taking income on the drip or accruals, is a great way to remove the risk of clawbacks.
“Generally non-indemnity commission also generates greater income than indemnity commission policies.
“Taking commission on non-indemnity for all policies means there will be no clawback, and therefore provision does not need to be set aside in the event you have a large clawback, which could often offset any other income you are due.”
Taking commission on non-indemnity for all policies means there will be no clawback, and therefore provision does not need to be set aside
Other ways of securing the future of the next generation include using vehicles such as cash, designated accounts, junior Isas and junior pensions.
Bank accounts may be set up to hold cash gifts for a child with their parents acting as the signatory responsible for managing the account. Meanwhile, some unit trusts and Oeics offer designated accounts.
This allows an investment to be set up in the name of a parent or parent but earmarked for a child or grandchild.
A junior stocks and shares Isa can be opened and managed on behalf of a child.
A pension can be opened for a UK-resident child under 18. Parents and grandparents can pay a maximum of £2,880 per year into this, which becomes £3,600 through 20 per cent tax relief.
Clare Moffat, pensions and legal expert at Royal London, says: "Making pension contributions for children is a great idea in terms of inter-generational planning. Not only does it provide a pension for the future of the child but it can save inheritance tax (IHT) for the person making the contribution.
"If the child is a taxpayer, it can save them income tax too. Anyone can make a pension contribution on another person’s behalf but often it would be grandparents or parents.
"It could be that grandparents have a final salary pension and aren’t spending it, so the excess is just building up in the bank account and creating more of an IHT issue. Instead of passing on cash to family members, they can instead make one off or regular pension contributions."
Making pension contributions for children is a great idea in terms of inter-generational planning
But pensions for children are not just for young children. Larger amounts could be paid if an adult child has relevant earnings, Moffat explains. The “normal expenditure from income” IHT exemption is often used to make these types of contributions on a regular basis.
If the adult child is a higher rate taxpayer, then the child could also claim back higher rate relief and could get their child benefit tax charge back. This would give the child more money in their pocket today as well as a pension for the future.
So how can advisers engage younger clients, once they have their foot in the door?
One way is through having intergenerational conversations.
Mehta says: “It is much easier to access multiple generations thanks to technology. So, from a logistical perspective, there is no better time than now to engage with multiple generations in one go.
“Whilst a daunting conversation for some, the role of the adviser as a facilitator can ease this concern and paves a natural way to discuss topics like wealth transfer and the opportunities it can bring.”
His advice follows research that estimates £5.5tn of wealth will be passed between generations in the UK over the next 30 years. Yet a significant number of inheritors are not sure they want to use their parents’ financial adviser.
The analysis outlined in M&G’s Family Wealth Unlocked report reveals that one in three advised families use the same financial adviser as another generation of their family or in-laws. Of those who have an adviser, 57 per cent share them with their parents.
A massive 65 per cent share an adviser with their grandparents, and 34 per cent with their in-laws or partner’s parents.
This also comes as almost three in four advisers anticipate the demand for wealth transfer advice to increase in the next three years, according to recent research from M&G Wealth.
However, problems can arise from managing different generations of the same family.
This is why it is important to introduce the younger generation to the adviser’s business early on, according to Alun Beynon, protection specialist at Scottish Widows.
He says: “This will create an intergenerational business unit where all parties feel included while also helping ensure that the parents’ assets under management and value is retained in your business.”
Having discussions about money or protection policies between different generations of the same family can seem awkward.
However, Gareth Davies, pensions specialist at Scottish Widows, says it is important to focus on the benefits whenever the conversation seems too sensitive to broach.
He says that to help ease the conversation around intergenerational planning, advisers should focus on three areas. This includes looking for ways to educate clients on the benefits of passing on wealth now as well as part of their estate.
Also, advisers can build in discussions of wider family financial needs and objectives as part of any annual review. Finally, he recommends involving a client’s family, in some way, in intergenerational planning conversations. A pension nomination form can provide a useful prompt to begin these discussions.
However, he adds that if a client does not want the family to be involved, there are other ways advisers can build in contingency. This can be done by asking a client to share contact details with the family or consider including a nominal percentage to their children, on top of their spouse, on any pension nomination form.
Davies says: “Intergenerational planning may sometimes feel like a sensitive subject. Every family is different in terms of how openly they discuss money and what will happen to the family wealth. So, focus on the benefits.
“Peace of mind can be a powerful motivator. And ensuring a client’s wishes and legacy are secured helps strengthen relationships and supports extending your advice.”
Aamina Zafar is a freelance journalist
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