James Hambro & Co financial planner Charles Calkin has several warnings for those tempted to give away too much of their wealth to dodge care costs and inheritance tax (IHT). Here’s his advice.
Whoever wins the June 2017 election, we know that the state is going to ask us to pay more for the care we may need in later life. Given the record of back-tracking, we may find the inheritance tax (IHT) rules end up changing too.
Some people, anxious not to erode an inheritance they have long wanted to pass to their children, will be tempted to start passing money on early. But I think you give your money away at your peril.
The best gift you can give your children is not to be a burden to them towards the end of your life when their resources may be stretched and meeting your needs could require enormous sacrifice.
I have a number of clients who are trying to help get their children on the housing ladder and at the same time supporting elderly parents in care who hadn’t been able to make provision for themselves. These are known as the ‘sandwich generation’.
Cost of care
We want to be in our homes as long as possible and most of us will need some support for that. If we need to move into a residential care home it might cost £5,000 a month. Typically, that might be for four years on average, unless the problem is dementia – when it could be longer.
Medical advances mean more of us are surviving illnesses that would have once killed us, and so we are living long enough to suffer from the cruelty of dementia. You can survive it for many years. The costs of the specialist care this requires can add significantly to the bills. I have a client with dementia who is paying £10,000 a month to be looked after in a home in south-west London.
It makes it very difficult to know how much financial provision you might need in later life.
What can you do if you want to pass on an inheritance?
First, what you can’t do – you can’t give the money away with strings attached. To avoid IHT (and quite possibly falling foul of any new regulations around care funding that might be introduced) any gift must be “without reservation”.
You might think you can give money to your children without any formal agreement and that they will look after you anyway, but that may not be possible. They may need the money to pay for a home, in which case the cash is likely to be locked in bricks and mortar and not available for you. In the event of a divorce – unless you have put in pre- or post-nuptial agreements – you may see half the gift disappearing with an ex-husband or former wife.
Trusts can be a helpful way of ensuring the right person gets to receive the money – and keep it – but they need to be drawn up carefully. Use an experienced solicitor.There is a risk that if you are considered to have divested yourself of money to avoid care costs that the arrangement will be challenged.
If you are a couple and are determined to leave money to your children, consider taking out a life insurance policy that only pays out on the second death and is written in trust for the children. This should be outside your estate for IHT purposes and is also helpful in avoiding probate delay.
If you want to give money during your lifetime, the most common way is by lump sum through a potentially exempt transfer (PET). For major gifts to be exempt from IHT you have to survive seven years after making the gift. If you die before that time a taper potentially applies – so if you die within three years the recipients may have to pay the full 40% IHT back. Between three and four years it would be 32%, and so on down to 8% if you die 6 to 7 years after making the gift.
This is a clean way to gift substantial sums, but it can encourage many people to give away too much too soon.
Passing money on gradually
There is another way to give without having to think seven or more years ahead. An underused facility is “gifts out of normal expenditure”. Document how much of your annual income you spend year to year. You can give the surplus away without the PET rules applying as long as you are able to maintain your usual standard of living. So as you tick off another healthy year you might feel able to pass on another chunk. The key is accurately recording the information. Normal gifts like Christmas and birthday presents are included within this allowance too.
In addition to gifts out of normal expenditure, each individual has an “annual exemption” of £3,000 (therefore £6,000 for a couple) worth of gifts they can make each tax year without these gifts being added to the value of an estate. This can be carried back one year if you haven’t fully used the previous year’s exemption.
It is also possible to give away wedding gifts of up to £1,000 per person, or a greater £2,500 for a grandchild or great-grandchild and £5,000 for a child.
Also exempt from IHT are payments to help with another person’s living costs, like an elderly relative or a child under 18.
Finally, it is possible to give any amount of gifts of up to £250 per person during a tax year as long as another exemption has not already been used on the recipient.
When the rules change…
Of course, all this information applies now and as I have indicated some of the rules are likely to change (and probably a number of times). Even if you normally like to manage your own financial affairs, this is one area where it is worth taking advice. The key point to make is that you shouldn’t let the tax tail wag the dog. Don’t jeopardise your financial independence.
Budgeting a substantial sum for care and then giving money away gradually as you can, using a combination of the techniques above, should hopefully help you achieve the balance between being able to look after your own needs and being generous to the following generations.