If you are retired or coming up to retirement you may be considering sharing your wealth by making financial gifts to your children or grandchildren.
But it is crucial to work out in advance whether you are likely to need that money in the future - because once you give it away you may not be able to get your hands on it again.
Financial planners therefore suggest that people thinking of giving away wealth conduct a cashflow forecasting exercise to try to work out as best as possible what their assets and liabilities - and income and expenditure - could be in the future. This will give them a picture of what their financial position could be.
“It’s important to remember that expenditure in retirement, as well as investment growth, are non-linear - they do not grow by the same amount each year” says Ammo Kambo, divisional director at wealth manager Brewin Dolphin.
“Spending can actually creep up in the early years of retirement as people have more time on their hands and go on more holidays, but then as they hit their mid to late 70s it tends to reduce as lifestyle become less active, only to creep up again in the 80s as the costs of social and nursing care become an issue.”
A financial planner can help you with this cashflow exercise. It involves compiling a list of all expenditure in the years directly before retirement, and then assessing which will no longer apply after retirement – travel to work, for example, lunches in the city and other work-related costs. It is important to identify the kind of lifestyle you want in retirement and how much this is likely to cost. Questions you need to ask yourself may include: how many holidays do you want; what is your fixed/essential expenditure in retirement, and what is your discretionary spend; whether you might trade down to a smaller property and what sort of surplus that might leave you with.
“Many of these things can be difficult to predict. Circumstances are constantly changing so we advocate doing a cashflow analysis then updating it every year to take account of developments in your life” says Kambo.
“A regularly updated cashflow plan can provide a snapshot of your financial position and really help with financial planning for future costs and inheritance tax plans. It can be a very powerful tool.”
Once you know where you stand, you can develop strategies with your financial planner. If you are facing a shortfall it might require a change in investment strategy to try and plug the gap. If you have a surplus you have scope for gifting to children or grandchildren.
When it comes to gifting, there are various options. Smaller gifts of up to £3,000 a year are automatically exempt from inheritance tax (IHT), as are gifts on marriage of up to £5,000 from parents and £2,500 from grandparents.
Larger gifts are covered by the Potentially Exempt Transfer (PET) rules. If you survive seven years after making the gift and no longer derive any benefit from it, then the gift is outside of your estate for IHT purposes.
There is also an exemption for gifts made of “normal” expenditure, which can be of any size but must meet three conditions:
- The gift forms part of the donor’s normal expenditure,
- It is made from income,
- It must leave the donor with enough money to continue their normal standard of living.
It is hard for one-off gifts to qualify – such gifts usually need to be regular, with evidence that they are part of a regular series, for example a payment into a life assurance policy or school fees.
Indeed, gifting to pay for school fees is an excellent way for grandparents to make substantial gifts to grandchildren while indirectly helping the parents, who will have a big financial burden lifted from them.
Control with trusts
You may want to maintain some control over the gift, or require some future access to the assets, in which case you might consider using a trust.
There are various types of trusts and they vary in terms of flexibility, access, control and tax efficiency.
“Essentially, the more access, flexibility and control you require over the money, the less tax efficient they tend to be from an IHT perspective,” says Kambo. “But for people who want to make gifts but still retain some benefit or access, trusts may provide an effective solution.”
Trusts, however, are an extremely complex area so specialist advice is essential.
Please note that this document was prepared as a general guide only and does not constitute tax or legal advice.
While we believe it to be correct at the time of writing, Brewin Dolphin is not a tax adviser and tax law is subject to frequent change.
Tax treatment depends on your individual circumstances, therefore you should not rely on this information without seeking professional advice from a qualified tax adviser.