Young and gifted
Grandchildren are often on the minds of those doing estate planning, but financial gifts must be made in a way that suits everyone involved.
Helping a grandchild build up a nest egg can give them a great start in life. What's more, giving money regularly and in smaller amounts can also be an effective way to minimise an Inheritance Tax (IHT) bill.
If you're in the fortunate position of being able to help, it's worth exploring your options. These include the opportunity to give away £3,000 worth of gifts each tax year (£6,000 per couple) without them being added to the value of your estate for Inheritance Tax (IHT) purposes. You can also make regular gifts out of your income (such as a monthly payment to a grandchild), and these are also exempt from IHT, so long as you can demonstrate they do not affect your standard of living.
Like most things that are worth doing well, estate planning can be a lengthy and complicated business. But by taking steps to find out what the rules are, and getting advice, you can make life easier for family members and still be confident that you have enough money to maintain your standard of living in retirement.
Here are four options for those with surplus income and capital to consider.
1. Junior ISAs
Junior ISAs are popular with grandparents looking to use their gifting allowance, as the money saved is free from any further liability to Income Tax or Capital Gains Tax. You can’t open a Junior ISA on your grandchild’s behalf, but you can pay into it up to their annual limit, currently £4,260.
The money can be invested in cash, shares or both. It’s worth bearing in mind that saving for children is typically a longer-term exercise, so the potential for growth could be better achieved by investing the money rather than leaving it in cash.
If the full £3,000 gifting allowance is put into a Junior Stocks & Shares ISA every year from a child’s birth, a tax-free sum of £87,664 could be available to the child by the time they hit 18, assuming a 5% annual growth rate*. This would be a huge help towards the costs of setting up home or going to university.
Once the child comes of age, the money becomes their property. So, if you are concerned about retaining control over how the money is used, you may be interested in using a trust structure instead.
A trust** can be an effective way to retain an element of control over when funds are received and how they are paid, while gifts made to a trust can reduce your estate for IHT purposes.
Trusts can be set up in different ways. For instance, an ‘absolute’ or ‘bare’ trust can be set up to benefit specific children, whilst also allowing withdrawals to be made at any time as long as they are for the child’s benefit – for example, to pay school fees.
A ‘discretionary’ trust is set up with a pool of potential beneficiaries. The advantage here is that whereas in a bare trust the assets must be distributed to beneficiaries who are over 18 if they ask for them, with a discretionary trust the trustees can retain assets until they think it is the right time for them to be distributed. Furthermore, new beneficiaries can be added to a discretionary trust. This can be useful if, for example, you have another grandchild in the future.
You should always seek advice when setting up a trust, as different kinds of trust trigger different tax liabilities.
3. A child’s pension
If you would like to invest for a grandchild’s later life, you could contribute to a pension for them. Once the pension is set up, you can help to improve the child’s retirement prospects and reduce your IHT bill at the same time. Family and friends can pay in up to £2,880 every year and the government tops this up with tax relief, so that £2,880 becomes £3,600. What’s more, the £2,880 yearly contribution falls below the £3,000 annual gifting exemption.
While it may be hard to imagine your grandchildren reaching retirement, by making a net contribution of £240 a month to a pension plan from birth until the age of 18, the fund could exceed £1 million by the time they reach 65, assuming an average growth rate of 5% a year*.
Remember that pension benefits can't usually be taken before the age of 55, and this minimum pension age is set to increase to 57 in 2028.
4. Lifetime ISA
Once children become adults, giving them money to save into a Lifetime ISA could help them save for a property or top-up their pension savings. With a Lifetime ISA the government adds a 25% bonus to everything saved up to £4,000 a year. Those savings must be used for either a deposit on a first home or a retirement pot accessible only after age 60. Withdrawals for other reasons are subject to a 25% penalty.
It’s worth noting that if your grandchild is in employment and their main aim is to put money aside for retirement, then it probably makes more sense to give them money to top up their workplace pension. This is because contributions not only attract tax relief at their highest marginal rate (20%, 40% or 45%), but also benefit from the all-important employer top up.
(Lifetime ISAs are not available through St. James's Place.)
In circumstances where your IHT liability cannot be eliminated, it can be worth giving some thought to tax efficiently providing for it through appropriate life assurance held in trust. In addition, it’s important to remember that your Will** should be reviewed regularly to ensure it accurately reflects your wishes.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
An investment in a Stocks & Shares ISA will not provide the same security of capital associated with a Cash ISA.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief generally depends on individual circumstances.
*The figure and growth rate used are for illustrative purposes only. The amount you get back will depend on the tax treatment and actual growth rate of the funds selected and may be more or less than the figure shown.
**Will writing involves the referral to a service that is separate and distinct to those offered by St. James's Place. Wills and Trusts are not regulated by the Financial Conduct Authority.