Many of us want to pass our wealth on to the next generation. But what do we need to consider to do this effectively – to maximise the benefits for our families while managing the balance between tax efficiency and control?

The challenges

How much to gift and when? You need to make sure you have provided for your own needs before passing any potential excess onto future generations. The earlier you can make a gift the more impact it is likely to have, as well as it being more likely to be tax efficient.

How much you need to set aside for your retirement is the first thing to think about. It can be hard to get a clear sense of this as it is affected by various factors which are outside of your control.

- The long-term average return. Even small changes in the returns we receive make a big difference and can have a big impact over time.

- Inflation. Although inflation is relatively subdued now, the long-term effect can be consequential. For example, £1,000 at the start of 1990 was only worth £488 at the end of 2019. (Source: ONS, Netwealth.) Our own unique inflation rate is also likely to be meaningful and is driven by how much we spend as we get older.

- How long we live. We are living longer and therefore we need more funds to pay for those extra years. For example, a 54-year old female has a 1 in 4 chance of living to 94 years according to the ONS – so we must ensure that our retirement pot is equipped to last longer than we may expect.

However, you can model for these factors above as well as the elements you do know such as your planned retirement date, target income and choice of risk level. Our powerful online tools can help you to get a clearer picture on how much you might need to fund your retirement.

What you should know

Gifting rules are applied to prevent individuals from circumventing inheritance tax (IHT), which is levied at 40% on estates above £325,000 (or £500,000 if it contains a residence). While you can give a gift of up to £3,000 a year to anyone without any tax consequences, for a larger gift to be fully outside of your estate you must survive more than seven years. There are no limits on gifts to spouses, civil partners or UK registered charities.

If you do plan to pass a meaningful gift on to your children or grandchildren, there are things you should contemplate to ensure it is done efficiently.

Tax efficiency vs. control

It’s important to consider the trade-offs between keeping control of your money and the tax efficiency of your gifts. In general, the more control you wish to retain the less tax efficient it will be. A simple gift for example to an adult child is very tax efficient, however, once you have given it to them you have no legal right to this money or control over how it is used.

You can wrap gifts in a range of more complex structures such as trusts or companies which can help to give you more control but add complexity, administration and cost as well as often increasing tax rates.

The right mix of outright gifts and more complex structures will depend on your objectives and in many cases the level of assets you would like to pass on. When thinking about the trade-off between retaining control and tax efficiency one option is to start with more frequent smaller gifts. This allows you to see how the beneficiary behaves as well as allowing you to start an education process of explaining your desired purpose for these gifts.

When to make your gifts

The sooner you make a gift the more beneficial it may be for your family, as the next generation’s cashflow could be stretched when they have to educate children and pay down mortgages. You can also ensure that gifts have a bigger impact if they are structured in a smart way and you make the most of tax wrappers.

For example, as we explored in this article you can turn £50,000 into £66,000 for your family if you are a higher rate taxpayer and make the most of your contributions. The benefits of placing your savings in tax-free wrappers can significantly improve your net returns and help you to achieve your overall goals – including gifting.

Your pension as an IHT planning tool

Assets within your pension are outside of your estate for inheritance tax purposes. So how you choose to draw down on your pension assets can have a major impact on what passes to the next generation.

An annuity gives you a guaranteed income for life and this security may give you the confidence to gift more. Yet you should note that annuity rates are close to all-time lows and they usually have no value upon your death.

Flexi-access drawdown gives you much more flexibility with your pension pot and lets any remaining assets be passed on to your beneficiaries after you die. However, you should be aware of the potential impacts of the Lifetime Allowance (currently £1,073,100), of the effects of inflation and how long you live and that the value of funds still invested can go up and down.

As pension assets are often a large portion of our overall wealth it’s important to think about how much might be left behind for the next generation. You may then want to invest this portion of your pension assets differently than the funds that you will be drawing an income from.

How the Netwealth approach can make a difference

Our intuitive technology and expert team help you to plan, invest and review your portfolios so you can achieve your financial goals. Planning ahead is made easy with our useful planning tools, a valuable addition to the insights from our advisers who are happy to talk about your specific needs at any time that suits you.

We also take away the hassle of investing for you and build efficient portfolios by keeping costs down. This focus on lower fees combined with tax allowances can make a big difference to your returns over time. The next generation are also well served through the Netwealth Network, which lets you invite up to seven family members to share in even lower fees from being part of your Network, with everyone keeping their investment independence.

Whatever your gifting goals are it is important to get the balance right between control and tax efficiency. You should figure out how much you can afford to pass on to the next generation and when is the most opportune time to do so. Pensions can be a helpful tool to pass on your wealth – and when you control the controllables around investing it raises the potential that you can give away more.

Please remember that when investing your capital is at risk.

Our advisers offer restricted advice that relates to Netwealth’s products and services and does not consider the whole market. Netwealth does not provide tax or legal advice and does not advise on transfers of pensions with safeguarded benefits.