Passing wealth on to the next generation sounds straightforward but doing it in the right way can take some careful thought.
For many families, the aim isn’t simply to reduce taxes. It’s also about making sure wealth passes to the next generation at the right time, in the right way, and with the right safeguards around it.
At Branch Austin McCormick, we’ve helped families consider a range of strategies for managing wealth in the long term and the right approach will depend on your circumstances, the size and type of your assets, and what you ultimately want to achieve for your family.
Here are some of the options worth considering.
Family Investment Companies
A Family Investment Company (FIC) is a private company that can be used by a family to hold and invest wealth. FICs are often used to hold investment portfolios or property, although there is no general requirement for them to invest in any particular type of asset.
One of the attractions of a FIC is the ability to separate ownership and control.
For example, parents might retain voting shares, giving them control over the company’s decisions, while transferring shares with beneficial rights to their children. This can allow wealth to be passed to the next generation while giving the older generation a degree of ongoing control.
There can also be tax advantages. A company currently pays Corporation Tax on its profits and chargeable gains, rather than the income tax rates that may apply if investments are held personally. The main rate of Corporation Tax is currently 25%, with a 19% small profits rate for companies with profits of £50,000 or less, subject to the relevant rules.
However, an FIC isn’t automatically a tax-saving vehicle. There can be tax when money is extracted from the company, and the way shares are transferred and structured can have Inheritance Tax implications. For example, giving away shares is generally a lifetime gift for Inheritance Tax purposes and may need to survive seven years to fall outside the donor’s estate, depending on the circumstances.
So a FIC tends to work best as part of a wider family wealth strategy rather than as a standalone tax solution.
Trusts
Trusts have been used for generations to pass wealth between family members while retaining a degree of control over how and when beneficiaries receive it.
For example, rather than giving a child a substantial sum at 18, a trust can provide a framework under which assets are managed for their benefit and distributed at appropriate times. The trust might allow money to be used for education, a first home or other significant milestones, depending on how it is structured.
This can be particularly attractive where you want to give younger family members financial support without handing over a large amount of money before they are ready to manage it.
Trusts can also provide a degree of protection in certain circumstances. For example, assets held in a properly structured trust may be treated differently from assets owned personally if a beneficiary later divorces. However, this protection is not absolute: how a trust is established and administered, and how its assets are treated during a marriage, can all be relevant.
There is also an important tax point. Trusts can have their own Inheritance Tax charges and reporting requirements, so they shouldn’t be viewed simply as a way of taking assets outside the tax system.
The key is to choose the right type of trust and structure it around what you actually want to achieve.
Junior pensions
A Junior SIPP can be a useful way of putting money aside for a child or grandchild while giving the investment many years to grow.
Under the current rules, you can contribute up to £2,880 a year to a Junior SIPP on behalf of a child. Tax relief can increase this to £3,600, assuming the full contribution qualifies for relief.
If £3,600 were contributed every year from birth to age 18 and achieved an average investment return of 6% a year, the resulting fund could be around £110,000 by the child’s 18th birthday, before charges and inflation. If that money then remained invested for several more decades, the power of compounding could make a substantial difference to the eventual value.
The important trade-off is access. A pension is designed for retirement, so the child cannot simply access the money when they turn 18. That can be a significant advantage if the objective is genuinely to provide for their long-term financial future, but less useful if you want the money to be available for university, a house deposit or other expenses in early adulthood.
There is another point worth considering when using pensions as part of an intergenerational wealth strategy. From 6 April 2027, most unused pension funds and pension death benefits will come within the scope of Inheritance Tax.
That doesn’t make pensions unattractive, but it does mean that the role of pensions in estate planning needs to be reviewed rather than assuming that pension wealth will always sit outside the estate for Inheritance Tax purposes.
Gifting
One of the simplest ways to pass wealth to the next generation is to give it away during your lifetime.
The rules are a little more nuanced than the often-quoted “seven-year rule”. Broadly, an outright gift can fall outside your estate for Inheritance Tax purposes if you survive seven years after making it. But there are also a number of specific exemptions that can allow you to make gifts without waiting seven years.
For example, you can currently give away £3,000 of gifts each tax year using your annual exemption. If you didn’t use the allowance in the previous tax year, you can generally carry it forward by one year, potentially allowing £6,000 of gifts in a single year.
There are also specific exemptions for wedding or civil partnership gifts: up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, or £1,000 to anyone else.
And there is an often-overlooked exemption for regular gifts made out of surplus income. If you have sufficient income to maintain your normal standard of living after making the gifts, regular payments can potentially be made without being subject to the seven-year rule. These could include helping with a child’s rent or paying into a savings or investment account.
This can make regular gifting particularly useful for families who have more income than they need and want to gradually move wealth down the generations.
The important thing is to keep good records. With lifetime gifting, being able to demonstrate what was given, when it was given and where the money came from can make things considerably easier for your executors later.
Can you gift your house to your children to avoid inheritance tax?
You can only make the gift your house to your children if you own the home outright and you do not have an outstanding mortgage. Some people gift their property to their children as a way to avoid or reduce their inheritance tax burden.
However, there are complications with this strategy.
If you gift your home to your children and you continue to live in the property, then HMRC will class it as a ‘gift with reservation of benefit’, a GROB. That means that the value of the property will be included in your estate for inheritance tax purposes, and the entire purpose for making the gift becomes redundant.
You can avoid this situation if you pay full market rent to your children to live in your property. This should be assessed every year by a specialist to verify that the rent is a true reflection of the market value. But paying rent is probably unappealing. Don’t forget that your children will also have to pay income tax on the rent that they receive from you too.
Th other thing to bear in mind is the risk of relinquishing ownership in your home. This can become a problem if your child is married and goes through a divorce. Then your home (which is now theirs) becomes an asset in the divorce proceedings. They could be forced to sell the home as part of the divorce, and you’d have to find a new place to live.
How we can help
There is no single “best” way to pass wealth to the next generation.
For some families, regular gifting may be the simplest answer. For others, a trust or Family Investment Company may provide the combination of control, flexibility and long-term planning they are looking for. Pensions and investment portfolios can also play an important role.
The right solution depends on what you own, who you want to benefit, when you want them to benefit and how much control you want to retain.
At Branch Austin McCormick, we can help you consider the options and build a strategy around your family’s circumstances and objectives. Our private client team can advise on estate planning, wills, Inheritance Tax and succession planning, as well as helping with the legal documentation needed to put your plans into place.
If you’d like to explore how you could pass wealth to the next generation efficiently while retaining the right level of control and protection, please get in touch with Helen Freely at hf@branchaustinmccormick.com to arrange a consultation.