How can we transfer wealth to future generations tax efficiently?

  • If Ralph’s wife does not need her Sipp for income it could be passed onto her beneficiaries tax efficiently
  • They could consider investing in assets which  are not liable for IHT

Reader Portfolio


Ralph, his wife and family


65 and 64

Description

Pensions, Isas and Sipp invested in funds and shares, VCTs, cash, residential property.

Objectives

Make gifts to children, help possible future grandchildren with education and home buying costs, mitigate IHT, average annual real investment return of 5 to 6 per cent over the long term. 

Portfolio type

Inheritance planning

Ralph is age 65 and his wife is 64. They receive defined benefit pensions (DB) of £84,000 and £27,500, respectively, a year before tax. His wife also receives a Swiss state pension of £2,000 a year, and will receive a UK state pension of about £9,300 a year from age 66 and half of Ralph’s DB pension after he dies.

Their home is worth about £900,000 and is mortgage free.

Their two adult children are financially independent. Ralph and his wife gave each child £300,000 to help them buy homes and the mortgages on these are nearly paid off. The children are also likely to inherit £250,000 each from a grandparent in a few years.

Ralph and his wife also featured in the Portfolio Clinic in January 2019 (Go back to basics – and use the seven-year rule, IC, 04.01.19) 

“We would like to help possible future grandchildren with education fees and property purchases,” says Ralph. “So we would like our investments to make average annual real returns of 5 to 6 per cent over the long term, probably for 20 years or more, and to transfer wealth across the generations of our family efficiently.

“Our average yearly outgoings are £30,000 to 40,000 a year so significantly less than our income. I have a likely terminal illness with a life expectancy of one to two years. And after my wife is age 66 her total income after tax should be about £61,000 a year. If she needs care in later life and a care fee cap of £86,000 is introduced in 2023, she will be able to pay for this out of her income.

 

“So we plan to make gifts out of income to our children, and or to possible grandchildren. We have been helping our children to pay off their mortgages and kept good records of our gifts to them. There may also be further contributions to my wife’s self-invested personal pension (Sipp).

“We have taken out two second death insurance policies which will total £310,000 over the next 20 years, and cost £1,200 a year. Payments from these will go into a trust of which our children are the trustees and beneficiaries. I estimate that this will cover all the inheritance tax (IHT) due on our estates.

“We will also look to get advice on how to manage IHT and have taken out lasting power of attorney for financial affairs.

“I manage my own and my wife’s investments, most of which are in individual savings accounts (Isas), and her Sipp. I also manage my children’s lifetime individual savings accounts (Lisas) and Isas (see charts). For asset allocation purposes, I treat all these accounts as one portfolio. I am also trying to interest and involve my children as much as possible in this.

“As we are not reliant on our investments for income I am happy to accept a fairly high level of risk. I hope that I would consider losses as purchasing opportunities.

“I first invested in 1986 when I bought shares in British Gas but nowadays I prefer collective investments to direct share holdings. I invest in both passive and active funds to try and keep costs down, and try to diversify our investments globally.

“I have also diversified my venture capital trust (VCT) holdings widely to try to reduce their risk. As I aim to keep my taxable income below £100,000 year and mostly use my entire annual Isa allowance, the VCT’s tax-free dividends have been especially attractive. But I make sure that the VCTs do not account for more than 10 per cent of the investment portfolio. I am now thinking of selling and repurchasing VCT shares that I have held for at least five years.”

 

Ralph and his wife’s total portfolio

Holding Value (£) % of the portfolio
Cash 239,283 21.91
HSBC MSCI World UCITS ETF (HMWO) 105,128 9.63
Scottish Mortgage Investment Trust (SMT) 69,240 6.34
Vanguard FTSE All-World UCITS ETF (VWRP) 67,614 6.19
NS&I Index-linked Savings Certificates 63,733 5.84
Stewart Investors Asia Pacific Leaders Sustainability (GB0033874768) 62,520 5.73
Worldwide Healthcare Trust (WWH) 52,296 4.79
iShares Core S&P 500 UCITS ETF (CSP1) 51,220 4.69
Legal & General Japan Index Trust (GB00BG0QP828) 47,923 4.39
iShares S&P 500 Information Technology Sector UCITS ETF (IITU) 37,089 3.40
Vanguard FTSE Developed Europe UCITS ETF (VEUA) 28,809 2.64
Unite (UTG) 28,250 2.59
Primary Health Properties (PHP) 24,576 2.25
Threadneedle (Lux) European Select (LU1598421698) 23,508 2.15
Vanguard FTSE 250 UCITS ETF (VMIG) 23,460 2.15
HICL Infrastructure (HICL) 18,458 1.69
Hargreave Hale AIM VCT (HHV) 16,864 1.54
Schroder Asian Income (GB00BDD29849) 16,374 1.50
Northern Venture Trust (NVT) 14,591 1.34
Northern 3 VCT (NTN) 13,631 1.25
Northern 2 VCT (NTV) 13,584 1.24
Foresight VCT (FTV) 12,495 1.14
Baronsmead Second Venture Trust (BMD) 11,313 1.04
SVS Aubrey Global Emerging Markets (GB00BNDMH797) 10,238 0.94
Baronsmead Venture Trust (BVT) 9,626 0.88
Albion Technology & General VCT (AATG) 7,175 0.66
Albion Enterprise VCT (AAEV) 7,152 0.65
Crown Place VCT (CRWN) 7,035 0.64
Kings Arms Yard VCT (KAY) 6,624 0.61
Puma VCT 10 (PUMX) 2,162 0.20
Total 1,091,971  

 

Holding Value (£) % of the portfolio
Scottish Mortgage Investment Trust  69,240 42.74
iShares S&P 500 Information Technology Sector UCITS ETF  37,089 22.89
Vanguard FTSE All-World UCITS ETF 36,695 22.65
SVS Aubrey Global Emerging Markets  10,238 6.32
Vanguard FTSE 250 UCITS ETF 8,749 5.4
Total 162,011  

 

     Holding Value (£) % of the portfolio
HSBC MSCI World UCITS ETF 46,952 35.32
Liontrust Special Situations  29,745 22.37
Vanguard FTSE All-World UCITS ETF  20,002 15.05
Pantheon International  18,227 13.71
Bluefield Solar Income Fund 11,735 8.83
JPMorgan Japan Small Cap Growth & Income  6,284 4.73
Total 132,945  

 

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS’ CIRCUMSTANCES.

 

Chris Dillow, Investors’ Chronicle’s economist, says:

You’e well diversified both geographically and across different asset classes, with NS&I Index-linked Savings Certificates and cash protecting you from inflation and equity bear markets. And you’re using tracker funds well, with only small allocations overall to active funds and direct share holdings. 

You are also making good use of VCTs which I applaud for two reasons – neither of which are their tax breaks. Disproportionate amounts of future company growth might come from unquoted firms because the UK stock market is already dominated by mature companies, many of which have gone ex-growth. And as it is almost impossible to predict which companies will succeed in the long term – in particular with unquoted companies – you need to spread money across several funds. One or two great successes or failures can result in big differences in VCTs’ performance so diversifying across VCT managers spreads risk.

Your US exposure, which you get via global and US equity tracker funds, and Scottish Mortgage Investment Trust (SMT), should have served you well. But with the Nasdaq Composite index down 14 per cent between the start of this year and late February, should you reduce the exposure to US equities?

Losses can be buying opportunities, but history warns us that they can be enormous before the buying opportunities emerge. For example, between 2000 and 2002 the Nasdaq Composite fell by 75 per cent. This is a warning that when valuations deflate they can inflict savage losses, not least because momentum buyers can become momentum sellers. You cannot avoid such losses just by diversifying equity investments globally.

We cannot quantify how great this danger is. There’s no point looking at earnings expectations because it is largely impossible to forecast earnings growth, so such expectations are a weak foundation for any investment strategy. Big share price falls for Netflix (US:NFLX), Meta Platforms (US:FB) and Peloton Interactive (US:PTON) following disappointing results illustrate this.

Instead, there are two ways to protect yourself from this risk. Watch 200-day moving averages, because selling when share prices fall below them can protect investment portfolios from terrible losses. For example, following such a strategy got investors out before the 2000-02 and 2007-08 bear markets.

You could also monitor the US yield curve. When 10-year yields fall below the Federal Funds rate, the target interest rate set by the US Federal Open Market Committee for commercial banks lending excess reserves to each other, it’s a lead indicator of big losses. At the time of writing in late February, these signals are mixed: the market is close to its 200-day average but the yield curve is still upward sloping.

You need some kind of exit strategy and these indicators should guide you.

 

Richard Watson,wealth management consultant at Mattioli Woods, says:

I am sorry to hear that you are unwell but hope that it is helpful to hear that you appear to be in a good position in terms of mitigating your IHT liability. Continue to keep records of any gifting out of normal expenditure as well as of larger direct gifts. And keep your children and wife involved in the investment decisions as their attitude to risk and capacity for loss need to be considered.

It is essential that you and your wife remain comfortable with the level of income you receive. At present you are well catered for by your final salary pensions, and wife’s Swiss State pension. If nothing changes, the rest of your investments can have a long-term, capital-focused objective.

Contact your NHS pension scheme to clarify what the position will be when you die as there are several different spousal options which depend on which scheme you were in and when you took benefits. Knowing what this is will be essential in your planning.

As your wife does not need income from her Sipp, it could be passed to her beneficiaries tax free. If she dies before age 75, her beneficiaries will not pay income tax on any income or lump sums they take from the Sipp. If she dies after age 75, her beneficiaries will be taxed at their marginal income tax rate on withdrawals. The pensions lifetime allowance rules apply to the Sipp and her final salary pension, so there could be a tax charge if the value of these pensions breach the limit which is currently £1,073,100.

Consider investing in business relief qualifying investments. Enterprise Investment Schemes (EISs) are even higher risk than VCTs but offer similar income and capital gains tax (CGT) reliefs after you have held them for at least three years. They also have the added benefit of 100 per cent business relief after you have held them for two years. Once the minimum holding periods have been met, assets that continue to qualify for business relief could be gifted during your lifetime or upon death, either directly or into trust for beneficiaries such as children and future grandchildren. And they could retain the 100 per cent IHT relief status for assessing tax due on lifetime transfers and discretionary trust charges.

Make sure that your wills are up to date and remember that transfers between married couples are not usually subject to IHT. If you pass your main residence onto direct descendants, you can benefit from the residence nil rate band of £175,000 each, if your total estate’s value is below £2mn. So together with each of your nil rate bands of £325,000, up to £1mn of the value of your own and your wife’s estates might not be liable for IHT. If the value of your total estate is above £2mn, for every £2 above this, the residence nil rate band reduces by £1.

I calculate that the current potential liability on the second death could be about £332,000 and subject to IHT of 40 per cent. This calculation is based on you not having used any of your nil rate bands on previous gifts, whether chargeable lifetime transfers or failed potentially exempt transfers. However, you have additional options for reducing the liability if your wife makes further gifts and/or investments in IHT-efficient assets such as business relief qualifying Aim shares.

But consult your tax and legal advisers before implementing any financial planning strategy.

The investments you hold are relatively high risk overall, given the significant weighting to VCTs, even though you have spread the risk across several of these. Your wife’s Sipp also appears high risk because it does not have an allocation to cash and a large portion of it is invested in Scottish Mortgage Investment Trust. This trust has suffered over the past few months because growth stocks have declined in value. But as the various portfolios have a good global spread of assets, and given your financial situation, I am not overly concerned by their position.

 

Asset allocation of wife’s Sipp
Holding Value (£) % of the portfolio
Scottish Mortgage Investment Trust  69,240 42.74
iShares S&P 500 Information Technology Sector UCITS ETF  37,089 22.89
Vanguard FTSE All-World UCITS ETF 36,695 22.65
SVS Aubrey Global Emerging Markets  10,238 6.32
Vanguard FTSE 250 UCITS ETF 8,749 5.4
Total 162,011  

 

Leave a Comment