Many of us spend a great part of our lives trying in one way or another to accumulate as much money as we can. We start by filling a piggy bank with coins, then put money aside for education, save up for a car, for a deposit on a house and – the big one – for our retirement.
Most of us never seem to have enough, but some fortunate people find they have wealth to spare, putting them in the happy position of being able to give part of it away.
However, what if doing so might leave us financially strapped ourselves? What are the legal pitfalls – and what about tax?
Follow some basic rules
There are three basic rules when deciding to give money away.
1. Make sure your own future is secure
The first and most important rule is that you should always look after your own interests.
Older people have, by definition, less time left in their lives to recover from poor financial decision-making or adverse events.
Any decision you make to part with an amount of cash, particularly if it’s in the spirit of giving children their ‘inheritance’ early, should be with the certainty that, if things go wrong, you will be able to put the mistake down to experience and not live the rest of your life with regret and in penury.
Since the launch of pension freedoms in 2015, which give people access to all their pension savings at once to spend as they like, according to the Financial Conduct Authority more than 120,000 people withdrew their pensions in full between July and September 2015, many without advice.
If someone has a secure income stream from another source – a final-salary pension scheme, say, or a rental property – cashing in a small personal pension pot can make a lot of sense, because a larger cash sum can create more benefits than being paid out in dribs and drabs. For instance, it could be used to clear a debt, including a mortgage, or be passed to children.
There is, however, evidence that some people are using the money they have set aside for their retirement. Some are exhausting savings to pay grandchildren’s university fees, even though there is a loans system in place for higher education that students can access, while older people who have given money away may find themselves refused credit when they are short of cash.
2. Tax planning is important
The second rule is a variation on the maxim ‘Don’t let the tax tail wag the investment dog’. No one likes to pay tax unnecessarily, but handing over money simply to avoid tax – particularly inheritance tax – may cause more problems than it solves.
Tax planning is an important part of putting your financial affairs in order, but always be wary of losing control of your money and ending up in a worse situation than if you had simply bitten the tax bullet.
3. Seek independent legal and financial advice
Third, take legal and financial advice before handing over money, to be sure you understand the first two rules. Not realising the implications of your actions is a recipe for disaster.
There are certainly ways to minimise tax while maximising control and still meeting your objectives. Always be cautious about entering a DIY arrangement where you may not be aware of potential pitfalls.
Giving a lump sum to your children
The reasons you would want to do this are obvious. You can help them to fly the parental nest with a deposit on a home, or help them to invest in a business.
Giving money away could cut the amount you eventually pay in IHT by a substantial sum if you live for seven years after making the gift.
But all is not plain sailing, particularly in respect of property purchases.
Cautious parents may in the past have entered a joint arrangement with their child or children to keep some control over the money they are handing over, such as buying a flat as a joint owner with the child. With the changes to the Stamp Duty Land Tax rules, an interest in a second property could cost you dear if you want to move house yourself. Since you now own an interest in another property, you could be liable for an extra 3% charge on the purchase of any new home.
Consider how things could change in the future
So, perhaps you will take a risk and give your child the money outright, losing control over it. Now if the child purchases a property with the cash, marries and subsequently divorces, the value of the property is likely to be included in any divorce settlement, meaning that a good proportion of the cash you have bestowed on your child is lost to the estranged partner.
Or if your child should die after marrying someone with children from a previous marriage, the property would very likely pass to the spouse and ultimately to children unrelated to you.
Hampshire-based solicitors Donnelly & Elliott warn: “A gift of money leaves you with no control of it, which can be disconcerting if, for example, the son or daughter is buying the property with a friend or partner, or if they’ve shown signs of not being able to deal with their finances in the past.
“Relying on your child to do the right thing can be disastrous, as one of this firm’s clients found out to his detriment after he realised his son had met a foreign lady, sold the house and taken the deposit with him to another country.”
It’s not just spare cash you need to be careful with. Some parents are trying to raise money for their children by mortgaging their own homes.
Equity release, a type of ‘reverse mortgage’ that does not need to be repaid until the house is eventually sold, can leave parents trapped in a home unsuitable for them in later life if the equity they are left with depletes as the mortgage interest rolls up with the original loan, leaving them unable to buy another property to move to. Take advice is always the rule, and use a reputable lender.
Gifts with strings attached
There are rafts of rules to prevent you from giving away assets while continuing to benefit from them. For example, if you give away your home in an attempt to avoid inheritance tax but continue to live in it, you could fall foul of the ‘gifts with reservation of benefits’ rule. It can apply even if you sell your home and gift the money to a child who buys a house with it, which you then share.
There are also the ‘pre-owned assets’ tax rules, which work like an income-tax charge on assets you formerly owned, and can catch you when reservation of benefits rules don’t.
Beware, too, of giving children money towards a property so they can get a better mortgage rate with a bigger deposit, and expecting to get the money back at some time in the future.
If you declare the money to be a gift, but it isn’t, that’s mortgage fraud. If the money is a loan, even at 0% interest, it will need to be declared to the mortgage lender and incorporated in affordability calculations.
The care-fees avoidance ruse
This is an area fraught with difficulty. Briefly, you risk falling foul of the ‘deliberate deprivation of assets’ rules, because even discussing with an adviser the idea of giving away money means that you are demonstrating deliberate intention. If you are found to have deliberately given away assets, they are treated as if you still owned them in any means test for receiving local-authority assistance with care fees.
In some cases the local authority can ask for money to be repaid or, if property has been purchased with the money, a charge can be placed on it to recover the cash when the property is sold.
The first question you need to ask yourself is: do you really want to throw yourself on the mercy of the local-authority budget when you might have been able to afford something better if you only had the cash?
Whether you have ‘deliberately deprived’ yourself of your own money comes down to motivation. If you have given away money at an early age, when you are in good health with no prospect of needing care, your motivation would normally not be regarded as ‘deliberate’.
However, the matter is one of interpretation, and there is no ‘safe cut-off point’, as there is with the seven-year rule for inheritance tax, and the local authority can look back as far as it likes.
The same applies to other means-tested benefits if you have exhausted your pension by spending the money or giving it away. People often do not realise that deliberately exhausting their pension savings could mean they lose any entitlement to means-tested benefits, potentially leaving some to survive on a reduced state pension.
The Department of Work and Pensions explained the rules last year: “If you spend, transfer or give away any money that you take from your pension pot, DWP will consider whether you have deliberately deprived yourself of that money in order to secure (or increase) your entitlement to means-tested benefits. If it is decided that you have deliberately deprived yourself, you will be treated as still having that money and it will be taken into account as income or capital when your benefit entitlement is worked out.”
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