Many clients are dipping into their capital to help children and other family members who have found themselves in financial trouble during the pandemic.
Clients are asking advisers about the possible knock-on effects to their own finances, but they are mostly putting a high priority on helping others.
One colleague said it was the biggest single reason clients had been drawing extra cash sums this year, and others agreed this was indeed a trend in 2020 and beyond.
Questions to financial advisers starting with ‘Can I afford to…?’ are very common at almost any stage in a client’s life – and now the key question is ‘Can we afford to help our children and grandchildren?’
The inputs for deciding whether a client can afford to provide immediate and unexpected help are like most other unexpected reductions in wealth, such as substantial investment losses. And the implications are also similar.
If the client is still working, they may have the option of working longer or earning more. Otherwise – and especially after retirement – the issue is the extent to which the fall in the client’s assets will impact on future income and the financial margin for safety.
It isn’t possible to be definitive about the answer because the question ‘Can I afford to give away £x?’ calls for a guess about the future. So the best way to help the client think about the possibilities is to use a cashflow planning tool with stochastic modelling.
Giving away a capital sum is analogous to determining the extent to which they could sustain a capital loss to their investment portfolio – the capacity-for-loss issue. The financial planner would need to employ realistic assumptions about the client’s future income and capital needs as well as future investment returns, levels and stability of income and inflation. And the stochastic modelling would test the many possible scenarios to assess the likely chances of the client covering their future expenditure needs if they made the big gift.
The whole exercise must be regarded as a best guess. For example, the prediction might be that giving away £50,000 to their daughter who was in financial trouble might mean there would now be, say, a 60 per cent chance of the client meeting their retirement income goals instead of the current 80 per cent likelihood. The client then has to make some decisions. They might conclude that a 60 per cent chance was good enough, possibly even too pessimistic. Or they might think they could afford to give the daughter only £30,000, which would increase the chances of meeting their retirement goal to, say, about 70 per cent.
But they might decide that even 70 per cent was not acceptable and look for other solutions. For example, they could retire later if they were still working, cut their expected standard of living in retirement, make the transaction a loan for at least a proportion, or increase their level of saving into the pension now to make good the possible future shortfall.
Intergenerational planning
Another person could afford to give their daughter £100,000, and it might make little or no difference to their future income and security because of their large amounts of income and wealth in relation to their current and future needs and wants. However, if this relatively rich person had two other children to whom they should be equally generous, the prospect of giving away £300,000 might be more worrying.
But if the client can make large transfers easily and without risk, the question arises of why they don’t give away more. The reasons for making gifts would be the pleasure giving and receiving often generates, as well as the satisfaction of saving inheritance tax. Making such a suggestion to a client – who might not have considered it – can make for some very effective intergenerational financial planning.
There may, however, be good reasons why the parent is not willing to make large gifts to the next generation or beyond. These could range from the potential recipient’s incompetence with money to the possibility of their relationship breaking down. In such cases, trust solutions are likely to be preferable.
Danby Bloch is chairman of Helm Godfrey and head of editorial strategy at Platforum
In all of the scenarios mentioned in the above article, a gift via a flexible reversionary trust could be an ideal solution.
Following consultation with the Settlor’s Financial Adviser, the independent (professional) Trustees, could (at their discretion) provide reversions back to the Settlor in the future (if ever required), whilst also being able to loan (or appoint) money to Beneficiaries at any time.
The original gift would fall outside the estate for IHT purposes after 7 years (assuming no PET’s are made in the interim).
Loans to Beneficiaries could be particularly useful to help protect family wealth in the event of divorce, bankruptcy or the recipient having their own IHT liabilities.
At the Trustees discretion, any loans could remain outstanding for the remainder of the recipient Beneficiary’s lifetime, thereby offsetting against their estate on demise. Once probate has been resolved, the loan could be repaid from the deceased’s estate and the Trustees could loan money to the next generation and so on, potentially protecting family wealth inter-generationally (given that such trusts have a 125 year perpetuity period)