Anna Sofat, managing director of Addidi Wealth, looks at the best ways to provide for your kids without leaving yourself short of funds.
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How to best provide for your children and grandchildren
Parents are hardwired to want to provide for their children, even after they have grown up.
But passing money down the generations is not without its pitfalls – when to do it, how much to give, and who to give it to are all questions that merit a lot of forward planning.
The key to intergenerational giving is achieving the right balance between protecting your children and grandchildren’s future and leaving them room to develop the life skills they will need to fend for themselves.
Finding the balance
Don’t forget about your needs!
The first thing you need to be absolutely certain of is that you can afford to give money away in the first place.
Make sure you will be able to cover your own financial needs – including through retirement – and factor in the high cost of residential care which may become needed at the end of your life.
Don’t forget your children have their whole life ahead of them to earn money – you don’t.
That said, giving money sooner rather than later can make a big difference to your family’s quality of life.
Children are the obvious recipients for gifts, but as we all live longer, people are increasingly skipping a generation and gifting to their grandchildren.
Start planning from your child’s birth
You can start thinking about your descendants’ finances as soon as they are born.
Children can save up to £4,128 a year in a Junior Isa in a tax-advantaged wrapper, although remember that they have unfettered access to the cash when they reach 18.
Age 21 or 25 are common access ages for trusts – any older than that smacks of control-freakery.
An increasing number of parents and grandparents are setting up pensions for children.
This is a particularly tax-efficient way of handing over money – as they get 20% tax relief on contributions even if they are not working.
You can pay up to £2,880 a year into a child’s pension and the Government will top it up to £3,600.
And they will be thanking you for it long after you are gone – because they won’t be able to access the money until they are 57 at the earliest.
School and university fees, first homes and the arrival of grandchildren are all key triggers for considering cash injections down the generations.
You might think of paying them through college, but letting the children take on the debt teaches them the value of money.
What’s more 77% of students will never pay off the full amount of their student debt, according to the Institute for Fiscal Studies.
Compare Junior ISAs with loveMONEY
Tax considerations
Money you give will not attract Inheritance Tax if you survive seven years from the date of the gift. You can also give £3,000 a year up to the date of your death Inheritance Tax-free.
On death, each of us can pass on an estate of £325,000 without incurring Inheritance Tax, and spouses and civil partners can pass on their allowances to each other, meaning the last to die can pass on £650,000 tax-free.
Estates selling family homes on death are given a further allowance of £100,000, rising to £175,000 per person by 2020, meaning couples with property will be able to pass on £1m free of death duties.
Pensions are a great extra estate planning tool as they fall outside your estate for Inheritance Tax purposes.
Beneficiaries receive the money tax-free if you die before age 75, or at their marginal income tax rate if you die after that.
With careful planning you can make a real difference to your children and grandchildren’s lives.
But whatever you do, make sure you don’t leave yourself short, and ensure that the gifts you do give don’t spoil the child’s journey to self-sufficiency.
How to cut your Inheritance Tax bill
Anna Sofat is managing director of Addidi Wealth, the finance boutique for women and their families.
Case study
The following illustrations will help bring to life typical intergenerational financial planning scenarios.
The first is based on one of my clients (with names changed) and illustrates when giving is not the best solution
Paula is a single parent aged 55 who owns her own home, although she still has £150,000 outstanding on her mortgage. She earns £40,000 a year, which is just enough to live on, and has virtually no pension savings.
Her only daughter Zoe is 22 years old and has just finished University in a city 200 miles away. Paula’s mother has recently died and she has just inherited £100,000.
Zoe is pressuring her mother to give her £50,000 for a deposit so she can buy a home in the town where she has been studying.
Paula wants to give her the cash, in part because she feels Zoe missed out on things when growing up because money was scarce.
But she is concerned about her own financial future, not least because there has just been a round of redundancies at her work.
After much soul-searching she takes our advice which is to give £5,000 to her daughter and use the rest to pay down her mortgage. Twelve months later her daughter has found a job abroad and is thriving in her new career
The next scenario show why pensions are essential to estate planning:
Jane’s husband died a year ago, leaving everything to her. She has a £1 million home as well as £200,000 in ISAs and £200,000 in a Self-Invested Personal Pension (SIPP).
She has two adult children – one male and one female – both of whom are stay-at-home parents who look after their own children rather than work.
Jane decides to live off her Isa cash rather than her pension because she knows the pension is tax efficient when it comes to Inheritance Tax.
She dies in 2020, having spent all her ISA cash.
Her £1 million home passes to her children without Inheritance Tax.
They also receive £100,000 each from her Sipp, which remains in a pension wrapper, from which they can each draw £11,500 a year tax-free under their own income tax allowance as they have no other income.
If they draw amounts between £11,500 and £45,000 they will pay income tax of 20%.