Intergenerational Financial Planning

Paul Killik for the Financial Times

This article was written by Paul Killik for the Financial Times, and was published on 1st April 2017.

Having been born shortly after the war, I am an early “Baby Boomer”, the most financially fortunate of all the generations that have recently been identified as such.

We have enjoyed a benevolent welfare state, free higher education, a rise in the property market the likes of which are unlikely to be repeated as well as final salary pension schemes that can no longer be afforded.

"What can we do to give the younger members of our families a better chance in later life than is presently on offer?"

It is interesting to reflect upon the evolution of the family over the last three centuries. In the 19th century we had parents and children; in the 20th century we had grand-parents, parents and children; and in the 21st century the norm is likely to be great grand-parents, grand-parents, parents and children. That is four generations alive at the same time, the Royal Family being an example.

Yet we still live by the mores of the 19th century largely in the mind-set and with the expectation that parents should bequeath to their immediate children. In so doing inheritance tax (IHT) will have taken three bites out of the original capital, before it gets to the fourth generation, and it continues to remain in the hands of the oldest generation throughout, giving little chance for long term growth.

Families need to plan to bequeath a large chunk of their estate to their younger generations, giving less or even nothing their immediate children, in order that the capital can enjoy the long term benefits of compounding, which Einstein called the 8th wonder of the world.

We are fortunate that UK Governments have been sufficiently foresighted to give us some helpful tools. Business Property Relief is one such and benefit can be achieved through investment into qualifying AIM companies which are IHT free two years after investment.

I have been advising private investors for very nearly 50 years and there has been one issue of planning against which I have often found myself confronted. It is the desire of the elderly to give their money away early, which has to be at least 7 years before their death for the full benefit, to avoid IHT.

"Unfortunately, too many people [...] live longer than they expected and find care home costs to be more expensive than they had assumed"

Unfortunately, too many people, having done this, live longer than they expected and find care home costs to be more expensive than they had assumed and they are left with insufficient funds.

A more intelligent approach is to determine how much that one would like to bequeath to the younger members of the family. You then discount that number by the growth that you might hope to achieve over the expected remaining years of life and invest it in an AIM IHT service.

However, you should also consider attaching a codicil to the will naming one’s grandchildren and great grandchildren alive at one’s death as the beneficiaries of the investments in the IHT service on the date of death. These monies to be invested tax efficiently for them in ISAs or equivalents.

Even unborn children can be covered by a discretionary trust that is set up for the purpose and this becomes more important the earlier in life that you plan, should you wish your great grandchildren to benefit.

In this manner one overcomes the common criticism that elderly people should not invest in small AIM companies. By dint of the codicil the monies have been mentally gifted to the younger members of the family, and these are appropriate investments for younger people. However, importantly the money remains in the name of the benefactor should they need to draw more in later life. Once given, it is difficult if not impossible to ask for money back.

To give a sense of the opportunity that this would offer to a young person over their lifetime, the table below seeks to demonstrate the power of compounding over a lengthy period.

I have assumed that an initial investment is made on the day of the child’s birth and that the monies remain invested until retirement which I have assumed at 70. I have also assumed an average annual rate of real return (that is after inflation) of 5%, which is marginally less than the Barclays Equity Gilt Study has computed since 1899 and over the last 50 years as well.

Another assumption is that the Junior ISA (JISA), the Lifetime ISA (LISA) and Junior SIPP (JSIPP) allowances remain unchanged at the 2017/18 level.

Scenario 1 shows that a single JISA subscription of £4,128 on day one of the child’s life could be worth £125,600 on the 70th birthday.

Scenario 2 shows the effect of investing £4,128 each year for 10 years, in other words a total of £41,280, could be worth £1,018,345 on the 70th birthday.

As will be seen from Scenario 3 if, from age 18, £4,000 was withdrawn from the JISA each year until the 50th birthday and reinvested into a LISA, where the government adds 25% to the subscription for 32 years, the resultant figure could rise to £1,228,124 on the same original capital investment of £41,280.

With the support of a benevolent family a child could, in addition to the JISA and LISA, also invest £2,880 on the day of their birth into a JSIPP. The Government provides a further £720 making a total investment of £3,600.

Scenario 4 shows that £3,600 could grow to £109,535 and Scenario 5 repeats the exercise each year for 10 years, a total investment of £28,880, could rise to £888,091.

Scenarios 6 and 7, show the effect of doing both the JISA and the JSIPP for 1 year and for 10 years. A total investment in both for one year could grow from £7,008 to £235,135 and from £70,080 to £1,906,436.

The income withdrawn from ISAs would be tax free, but from SIPPs would be subject to income tax. However, under current rules 25% of the SIPP can be withdrawn tax free from age 55 rising to 57.

We encourage you to contact your Investment Manager if you would like to discuss any of this further.

Alternatively, if you are new to Killik & Co, please do contact us on info@killik.com.