The silver lining to a bear market is that the best time to pass on your assets to relatives and other beneficiaries is after they have fallen in value.
Transferring the ownership of shares or any assets to someone else is a disposal event for capital gains tax (CGT) purposes, even if you don’t actually sell the shares, said Ian Dyall, head of estate planning at Evelyn Partners.
Let’s imagine that your share portfolio has doubled in value over many years. At the start of this year, it was worth £100,000 (a £50,000 capital gain on a £50,000 initial investment). The recent stock market volatility has knocked £10,000 off the value of your portfolio, reducing your overall capital gains by 20%. CGT is now payable on £40,000, not £50,000.
For people who started investing a long time ago, the bulk of their wealth consists of capital gains, so the sums involved can be significant, he pointed out.
Pension fund and ISAs are exempt from CGT, so this only applies to shares held in a general investment account. Many of Evelyn Partners’ clients have six or seven-figure sums in general investment accounts, having filled their pension and ISA allowances, he noted.
Estate planning is a balancing act between CGT and inheritance tax (IHT), Dyall continued. Gifting during life incurs a CGT liability that would have died with you.
Yet the maximum rate of 24% levied on capital gains (i.e. not the asset’s value, just the profits you’ve made) is far less than IHT, at 40% of the entire asset.
The scenario to avoid is paying CGT yourself, as well as your beneficiaries having to pay IHT on the same assets. This would happen if you died within seven years of making a gift, meaning that the assets fall within the remit of your estate.
However, if this did happen, assets passed on after falling in value during a bear market would incur a smaller IHT bill because they would be worth less at the point of transfer.
Money given as an ‘outright gift’ – meaning there are no strings attached and the original owner does not continue to benefit from the assets – falls outside of your estate after seven years. This means people who expect to live for more than even years can pass on substantial amounts of wealth as ‘potentially exempt transfers’, Dyall said.
However, people are often reluctant to make unrestricted gifts, fearing perhaps that their children might get divorced or are not good with money, he explained.
One option is to establish a trust and become a trustee, so you can stipulate how much your beneficiaries receive and when, and how the money is invested in the meantime.
Gifts above the nil rate band of £325,000 per person incur a 20% tax charge on the excess, so people usually try to keep gifts within the £325,000 band, which is renewed every seven years.
This also applies to money put in trust. If a bear market reduces the value of your assets, you can essentially put more assets (for instance, a larger number of stocks, which are now worth less) into a trust and stay within the £325,000 nil rate band.
Markets are usually cyclical, Dyall said, so eventually the valuations of your assets are likely to recover, and when they do, they will already be within the trust wrapper.
Sharp, short-term market movements also have implications for how much IHT beneficiaries have to pay.
The probate value of someone’s assets is calculated using valuations on the day they die. If someone inherits a portfolio of shares but the market subsequently plummets, “they’d be paying IHT on values that no longer exist”, he pointed out.
If the beneficiary sells those shares within 12 months of the giver’s death, they can replace the probate value with the sale price on their probate forms and calculate their IHT liability based on the new, lower valuation.
Beneficiaries need to use either the probate value or the sale price for all the shares they sell within 12 months. “You can’t pick and choose. You can’t sell one share at a big profit and keep the probate value, then sell some at a loss,” he noted.
The only snag is that if the assets subsequently recover, the beneficiary will net a larger capital gain, which may be taxable, but CGT is much lower than IHT.
Tax and estate planning may not receive as much airtime as investing, but they can have a far greater impact, Dyall argued.
A lot of investors – and their financial advisers – spend a huge amount of time focussing on investment considerations to “squeeze for 1% more returns”. Yet for elderly clients whose main motivation is to pass on as much of their wealth as they can, IHT is far more important. “Investment considerations are unlikely to make 40%,” he pointed out.
Another issue is that people often leave gifting until very late in life because they are worried about their money running out or spending down their wealth “feels alien” after saving throughout their lives.
This is where conducting a cashflow analysis with a financial adviser can help people understand how much money they need to achieve their goals and how much they can afford to spend and/or give away.
If people start estate planning when they retire, they can give their money away gradually and take small steps. But if people leave it too late, “all that wealth is going up and up and the problem becomes more difficult to solve”, he pointed out. “You then have to take drastic steps.”