The new Lifetime ISA has sparked a lot of interest, especially among younger people. It also provides an opportunity for the canny older investor looking to help the next generation now and minimise the amount of inheritance tax their estate pays one day.
Commentators have suggested that the next decade or so will mark the end of traditional inheritance as we know it. Parents and grandparents are more frequently using their accumulated wealth while they are still living to help younger generations – known as a ‘living inheritance’. Often, this will take the form of equity released when downsizing or the tax-free lump sum from a pension, and may be used to help struggling millennials onto the property ladder.
How the LISA can help
With the Lifetime ISA (LISA) now available to those aged 18-39, investments of up to £4,000 per year made in the name of a child or grandchild (over the age of 18) will qualify for an additional 25% contribution by HMRC, as well as tax-free growth and income both while growing and, unlike a pension, when accessed.
Lifetime ISAs can be a great way of providing a nest egg for your children or grandchildren while you are still living. They are less accessible than a traditional ISA, and so offer some built-in protection from unwise spending.
Minimising your inheritance tax
Usually gifts above £3,000 are included in the valuation of your estate for seven years after they are made. These can reduce your ‘nil rate’ inheritance tax band which is £325,000 – plus £175,000 if you have a house which is inherited by your children. Any money inherited above the nil rate band is taxed at 40%.
However if the gift is set up as a regular payment from income, for example £333 per month, the money is not counted against your nil rate band and is regarded as immediately outside your estate as long as you are not impoverishing yourself.
That £4,000, if counted as part of your estate above your nil rate band, would have been worth only £2,600 after inheritance tax is paid.
So, by combining the 25% contribution by HMRC with the 40% inheritance tax saving, you will be giving your children or grandchildren (or anyone you wish who is over 18 and under 40) £5,000, where they might previously have received just £2,600.
Using the LISA in this way means that you can help the next generation sooner, seeing your money put to good use while you’re still around. Plus they’ll also benefit from the 25% government top-up.
The rules governing the Lifetime ISA mean that there is a level of sensibility control built in as money can only be accessed to buy a first home or when the beneficiary reaches the age of 60.
While more flexible than a pension, the LISA is not completely flexible. There are penalties if the recipient uses the money under the age of 60 for something other than buying a first home costing less than £450,000. Not everyone wants to own property, and they may need the money for another sensible reason.
Withdrawing from a LISA under any other circumstances means that the entire government contribution is forfeit, with an additional penalty on top.
You do lose control of the money as you are required to give it away in order to benefit from the inheritance tax advantage, and so it must be saved in the recipient’s name. This also means you won’t have the money for any unforeseen costs, so it’s wise to thoroughly consider the potential downsides.
Other points to consider
Not all estates will be valuable enough to incur inheritance tax. The exact threshold can vary from £325,000 to £1 million, depending on whether you are married and if you leave your home or its value to your direct descendants (children, grandchildren, etc.). If you’re in doubt, it may be worth seeking independent estate planning advice.
You can set up a similar arrangement for any ISA, investment or savings account – you won’t get the 25% top-up, but inheritance tax benefits can still apply.
See what your children could save
Use the Nutmeg Lifetime ISA calculator to see how much your children or grandchildren could save with a stocks and shares Lifetime ISA.
If you’re still not sure whether the Lifetime ISA is right, you may want to download our PDF guide.
As with all investing, your capital is at risk. ISA rules apply. Tax rules may change in the future.
A Lifetime ISA may not be right for everyone. You must be 18–39 years old to open one. If you need to withdraw the money before you’re 60, and it’s not for the purchase of a first home up to £450,000, or a terminal illness, you’ll pay a 25% government penalty. So you may get back less than you put in.
Compared to a pension, the Lifetime ISA is treated differently for tax purposes. You may be better off contributing to a pension.
If you choose to opt out of your workplace pension to pay into a Lifetime ISA, you will lose the benefits of the employer-matched contributions.
If you are unsure if a Lifetime ISA is the right choice for you, please seek independent financial advice.