Written by:
Tom Glanville
Senior Financial Planner at Amber River Shipman Wealth
One fairly common question to a financial planner revolves around grandparents wishing to help their grandchildren; after all who would not wish to do so?
Ignoring giving them some cash when you see them, it can be quite tricky deciding the best way to help them with larger costs. For example, funding education needs or helping for a deposit on a house. Then there can also be the family dynamics; if there are a number of grandchildren looking to be fair to all of them, irrespective of perceived need. Or what to do if some of your children have children of their own and others do not, and should you make provision for potential future grandchildren if you have helped the existing ones now?
With so many questions quite often the result is the grandparents do not do anything, which can be a shame if their estate ends up paying inheritance tax when they die.
I find when confronted with a lot of “what ifs” it is easier to work through an example. In a previous article the River Family was used to explain, or at least make a start on explaining, intergenerational financial planning. So I will use them again.
Paul and Helen River have 3 children and currently 4 grandchildren. Paul and Helen have a successful family business and are quite wealthy, and particularly post April 2027 when their pensions will count in the inheritance tax calculation the family will face a large inheritance tax liability on their deaths.
One of their granddaughters, Sally, who is 6 years old, is struggling at school and Helen in particular is keen to help fund private schooling as she and Sally’s parents Toby and Joanna do not feel the current school is doing enough to help Sally. There is a good local prep school which has a preprep section.
If advising on this the questions to ask would be:
What will it cost and can you afford it? Best way to fund it if you can afford it? What about the family dynamics and being fair to all the family?
Regarding the cost, this will depend on how long the school fees are to be paid for, does this include secondary education? Whether other grandchildren are to benefit as well will make a huge difference to the overall cost.
In some ways it is better to look at the third point first. Do Paul and Helen wish to be fair across the family unit? If so does that include other grandchildren, current and potential further ones in the future? What about David their son, who has no children – do they feel he is being disadvantaged if they help his siblings’ children? Once those questions are answered then a better idea of overall cost can be worked out.
One of the interesting exemptions within the rules for Inheritance Tax is the lifetime transfers for normal out of income exemption, commonly known as gifts out of surplus income. So if Paul and Helen have surplus income to cover the school fees for Sally this will also benefit the family in reducing the potential Inheritance Tax liability.
This exemption has to date been little used generally but with the changes to pensions being included within the Inheritance Tax calculations post April 2027 it will become far more popular. This will inevitably mean HMRC will be checking claims far more carefully to ensure they comply with the rules. These are:
Gifts must be made out of income not capital.
Are regular payments being habitual or normal expenditure
After making the gifts you have sufficient income to cover your expenditure without reliance on capital.
As Paul and Helen run their own business, they could potentially have flexibility as to the income they draw. Historically they have enjoyed a good income but looked to leave money in the business to fund expansion. As none of their children wish to take over the business from their parents and as the business is very financially robust, they do not see the need to do this now. On the advice of their accountant, they have tended to draw mostly dividends from the business, but with the retained profit within the firm they could look to pay far higher dividends.
In consultation with their accountant, one option may be to pay a special dividend or dividends, over a number of years. If they could prove, (more on that later), this would be surplus income they could potentially put in a Trust to benefit the grandchildren’s education and that money would be immediately outside their estate for the inheritance tax calculation should they die. I said if they could prove, but that is not actually correct. How the exemption works is the executors have to claim the exemption when the inheritance tax is calculated. That involves detailing the income and outgoings for the relevant years of the gifts being made. This can be quite a task detailing the figures for say 6 years ago if detailed records have not been kept.
In addition to the potential inheritance tax saving, one major benefit of a Trust is it could allow for grandchildren current and in the future. With appropriate advice Trust structures can potentially allow for use of the grandchildren’s’ personal tax allowance, so this can be a very tax efficient solution. However, the rules and tax position can be very complex hence appropriate advice is needed.
Even if it were not possible to class the gifts as out of surplus income, gifts which exceed the annual £3,000 allowance, which were made more than 7 years prior to death, would be beneficial to reducing the potential inheritance tax liability. So as with most gifting the answer to “when” is the sooner the better.
It seems very unlikely that the Inheritance Tax revenue the Government receives will not continue to increase in the coming years and as a result more people will want to look at ways to benefit their family over the taxman. Therefore, advice in this area will become increasingly important for far more clients.
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