Advisers are often approached by clients who are concerned about passing on wealth to their dependants, and the amount of tax this might incur.
Rather than jumping straight to solutions, which can be based on off-the-peg solutions that are tweaked to fit, advisers can use cashflow planning to illustrate various, individualised scenarios the client can explore, allowing them to decide which one to get advice on.
In the below case study, Lauren Whitters, financial planner at Johnston Carmichael Wealth, illustrates what such a service could look like.
The clients
- Robyn & Charlie Smith are a couple in their 60s who are planning to retire in a couple of years’ time. They are both in good health and have a son together, Alex, who is hoping to buy his own home soon.
- Robyn is currently earning £75,000 as an accountant and Charlie is working part-time earning £25,000 as a gardener.
- They own their own home worth £750,000, which is mortgage free, and have £50,000 cash in their joint current account and a further £200,000 in cash savings.
- They have spent a few years building up their stocks & shares Isa portfolios that they self-manage to £500,000.
- Robyn has a personal pension pot of £500,000 and Charlie has a final salary pension already in payment of £1,000 per month. They will both be due a full state pension at state pension age.
- Robyn is planning to withdraw the full pension commencement lump sum available from their DC pension to fund the early years of retirement.
- Robyn and Charlie feel they live quite comfortably at present, and estimate their joint living expenses are just over £43,000 a year. They also spend around £5,000 each year on holidays, and replace their car every five years or so.
- They recently gifted £25,000 each to their son Alex, which he is planning to use to get on the property ladder.
- They initially got in touch to discuss how to structure their retirement income, but it became apparent during initial conversations that they have a potential inheritance tax liability. During the initial discussion they agreed that their primary objectives are to ensure they are able to live comfortably throughout their retirement, and thereafter they would like to pass on as much of their wealth to their son Alex as they can.
Base case
The first stage is to build a cash-flow model of their existing position, and some of the output of this is shown below.
The following three graphs illustrate the position for Robyn & Charlie from present and throughout their lifetime (10 years post cohort life expectancy) in terms of overall cashflow, net assets, income and expenditure and projection of IHT liability.
Overview
Income and expenditure
IHT
While there are no immediate concerns regarding the overall affordability and sustainability of their existing retirement plans, Robyn and Charlie were taken aback by the potential amount of inheritance tax payable on second death and would like to consider how this could be mitigated to let them pass on as much as possible to their son in future.
They would also like to understand whether there are any other ways to improve the overall efficiency of their plan.
Scenario 1
The base case cash flow is updated with the following suggestions:
- Instead of Robyn drawing maximum PCLS at retirement, the PCLS is taken gradually along with taxable income in the form of Uncrystallised Funds Pension Lump Sums. This is between employment ceasing and state pension age in order to utilise their personal allowance that would otherwise have gone unused;
- This frees up assets to be gifted, earmarking a further £300,000 gift to Alex in a few years’ time;
- Other income and expenditure have remained constant.
IHT position
These suggestions result in an improvement to their IHT position, in that the potential IHT liability is reduced but not fully mitigated. It also gives Robyn and Charlie the confidence that they can afford to gift more money to Alex.
Scenario 2
As per scenario 1 with one further change, in that £325,000 of Robyn and Charlie’s existing Isa portfolio is converted to business-relief qualifying assets.
IHT position
As can be seen above, net assets remain very similar to scenario 1 but the potential IHT liability has now been substantially reduced.
Robyn and Charlie should be able to lead a comfortable retirement, retaining access and control of the majority of their wealth and liquid assets during their lifetime to pass on to their son Alex.
Comparison of scenarios
Net wealth position
As can be seen in the below comparison, Robyn and Charlie’s net wealth begins to substantially diverge from age 67 when the gifts of £300,000 are passed to the next generation.
This may appear, at first glance, concerning, however when we consider the IHT position, the full story becomes clear.
IHT comparison
The final scenario, which includes both additional gifting and business relief investments shown in red, is projecting a large saving in liability to IHT with the result that the net value passing to the next generation is substantially higher.
Stress testing
All three scenarios will be stress tested for market crashes, changes in circumstances and higher inflation and lower returns.
By way of example, the graph below shows their net wealth inclusive of property after a 28.08 per cent fall to invested assets in year one of retirement without an assumed short-term recovery and illustrates that, even in an extreme situation, the clients have affordability to undertake advised actions.
