How can I provide an inheritance and keep taking income?

Our Head of Wealth Planning explains the options open to clients trying to solve a common problem

05 Oct 2017

James Gladstone

James Gladstone

Head of Wealth Planning

The aim of a lifetime of wealth creation and saving is to provide yourself with enough money to fund a comfortable retirement – and enough to hand a decent inheritance to your children and grandchildren.

It is a common concern that wealth planners are asked about. It is certainly something that I often hear. Balancing the two objectives can be difficult. The capital you have built up needs to generate the right amount of income. That in itself has become a challenge in the age of rock-bottom interest rates.

But how much income do you take, when you don’t know how long you’ll live? How much money will be left to hand down? Should you gift money? Sound financial planning can go some way to help with mitigating what might be unnecessarily paid on your estate.

There are a number of options available. One is to make use of a little-known type of specialist trust that meets both aims: to minimise inheritance tax and to provide an income. A Discounted Gift Trust involves giving away a lump of money to the intended recipients of your estate - but retaining the right to an income from the money.

The money, in effect, is divided in two.

A portion of this capital immediately moves outside of your estate, which is one of the trust’s most powerful attributes, given the rigorous limits around the usual gifting rules (see below).

Within a Discounted Gift Trust, part of your capital can be “discounted”. This amount is removed from your estate. The amount that can be discounted depends on the level of payments you choose to take. It is also based on your age, sex and health. Put simply, it depends on your life expectancy. The calculation is not dissimilar to how conclusions are reached on annuities.

If you opt to take higher payments and are estimated to have a longer life expectancy, you will require far more of the capital to provide an income. It means more of the money is immediately discounted and removed from your estate. Opt for lower payments and less will be discounted.

There are many nuances and the knowledge of a wealth professional is needed to navigate these.This is not the only way to reduce your inheritance tax liability and retain a stream of income.

Another rule that could help is “business relief”. This was devised to stop inheritance tax forcing the break-up of family businesses. Demands for tax of 40% when a child inherits their parent’s business could end up bankrupting that business, which was rightly deemed undesirable. So a rule was developed to avoid such scenarios.

There are various ways this rule is applied outside of the small, trading family business. One of these is by buying stocks on the Alternative Investment Market (AIM). This is the junior version of the London Stock Exchange, launched in 1995. It allows companies to list on public markets but with less onerous requirements.

Certain AIM stocks qualify as being exempt of inheritance tax by virtue of this “business relief”. HMRC judges it on a case by case basis. Property businesses and firms involved with banking or legal services do not qualify, for example. The stocks must also be held for two years in order to qualify for the relief.

Like companies listed on the main market, dividends may be paid to investors which they can use to supplement their income in retirement. AIM stocks can be more volatile than those on the main market and reliable income stocks, in particular, can be harder to find. The FTSE AIM 100 Index, for instance, only yields 1.3% compared to income of 4.2% for the FTSE 100 (as at 5th October 2017, Bloomberg).

A wealth manager can help negotiate the selection of appropriate investments in order to build a well diversified portfolio, which will contribute towards managing the inherent risk of investing in smaller companies.

An added bonus is that AIM stocks can also be held in an ISA, offering even greater tax efficiency. This means income tax is mitigated on any dividends the stocks provide. And as with any ISA, the allowances can now be retained by an inheriting spouse or civil partner. Both rule enhancements have been made in the past few years.

As ever, the rules are subject to potential tinkering by the government. You need to keep up with the constant change or rely on a wealth manager to do this for you.

The good news is that there are ways to give away more money free of inheritance tax and still provide you with a decent income.

What can you gift?

The rules on gift exemptions are complex but worth understanding if you are to minimise the amount of your estate that will be liable to the 40% inheritance tax rate.

The basics are:

  • You can give away £3,000 worth of gifts each tax year. This is the “annual exemption”. You can carry forward one year’s unused allowance to the next, accruing a total allowance of £6,000.
  • You can also gift money for Christmas or a birthday. You could also give a wedding gift of up to £1,000.
  • You can also make someone, or various people, gifts of up to £250 each year - as long as you haven’t used the other exemptions on the same person.

If the gift exceeds an available exemption and is deemed to be capital in nature, the amount of tax will depend on how long you live from making a gift. The effective tax rate falls after three years of making the gift. Once seven years have passed, the gift moves out of your estate.

Lastly, one other lesser known exemption is the ability to give away unlimited sums each year and for these to be immediately exempt from IHT without any seven-year survival period. In order to qualify for this exemption the gift must be from surplus income and also be regular in nature. A pattern must be established and the payments cannot be from capital. This area of the rules is quite complex so advice should be sought to ensure gifts qualify for the exemptions.






Nothing in this article should be deemed to constitute the provision of financial, investment or other professional advice in any way. Statements concerning taxation are based on our understanding of the taxation law in force at the time of publication. The levels and bases of, and reliefs from, taxation may change. You should obtain professional advice on taxation where appropriate before proceeding with any investment. Shares in AIM & ISDX market companies are likely to be high risk and volatile. The price of shares and income derived from them may fall as well as rise and there is the possibility that investors could lose their entire investment. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This article may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.


James Gladstone

James Gladstone

Head of Wealth Planning

James joined in 2012 and is Head of Wealth Planning. James is responsible for advising some of our largest clients on broad wealth planning issues including retirement and estate planning, investment structuring and wealth protection. He is also responsible for the Wealth Planning business within Cazenove Capital. Previously he was Head of Financial Planning at UBS and Financial Planning Director at Rathbones. James has over 18 years’ experience and is a Chartered Financial Planner.


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