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In the grounds of large estates you often find a more modest dwelling, called a “dower house”. In the past, should the owner of the estate die, the widow — or dowager — would move out and allow the next generation to take over the main house.
When I use the phrase “more modest”, everything is relative. Clarence House was the Queen Mother’s dower house. It has four storeys and at one time had a Russian Orthodox chapel in it.
For centuries the aristocracy has practised this model of passing on the large family home before death — you might call it the “dower principle”.
But in recent months a growing number of clients have asked whether they ought to do the same, giving their home away to their adult children in the hope of minimising inheritance tax.
Some intend to gift the property but still stay living in it. Others find the large house increasingly challenging as they get older and want to give their children and grandchildren the benefits of living there. They move into an annex or granny flat while their son or daughter and family move into the main house.
In their dreams they see themselves helping with childcare, doing odd jobs and having the security of someone younger on hand to help if needed. Intergenerational living like this has its appeals. But if you’re doing it to try to save inheritance tax, you may be disappointed.
First, many clients know that a gift will set the clock ticking on the seven-year wait before it is no longer liable for IHT. But this generally won’t work if you continue to benefit from it. If you intend to keep living on the property — whether that’s in the whole place, a part of it, or a “dower house” in the grounds — your gift will not reduce your estate unless you pay the new owners a market rent for staying there (and review it regularly to keep up with the market).
Can you afford this on top of the property gift? Maybe not. For some, the rent might seem a way of adding more to the intergenerational transfer of wealth. But remember, the new owners will pay income tax on that rent, which may be as much as 45 per cent (and the equivalent of 60 per cent if the gift takes them into the income bracket of between £100,000 and £125,140). Ultimately, the income tax paid on the rent may outweigh the IHT saving.
Multi-generational living also has its drawbacks. How exhausting are the grandchildren when they visit? Can you imagine living alongside them? Or what happens when that cute toddler turns into a boisterous teenager who invites his friends round to his adjoining bedroom for band practice?
Think, too, about what happens if your children divorce. A friend who moved with her husband and young children into a house with her in-laws in a flat above lived happily for several years.
They all got on well, until she and her husband did not. When the couple separated the house had to be sold and suddenly the mother-in-law — who had been so helpful and positive — became embittered and angry. And you could see why. She was being forced out of her home and had lost ready access to her grandchildren and a beautiful garden.
You need to ask yourself: is it wise to put yourself in such a vulnerable position to save tax?
Bear in mind, too, your IHT liabilities if you die earlier than expected. These are unlikely to be worse than they would have been without the gift — particularly as any growth in value of the gifted asset will be outside your estate. Still, the IHT on a gift within seven years of death can be a shock for a grieving family. Consider life insurance that pays on the death of the second partner enough to cover any tax bill.
Capital gains tax is not usually an issue on transfer of a property that has always been your main residence, but any IHT planning should aim to preserve that valuable relief for gains on a future disposal.
Consider other routes, too. A gift of a share of your home to your child could be exempt from the “gift with reservation” provisions that prevent you making a gift and then continuing to live there. To qualify, both you and your child must occupy the property after the gift and, in essence, you must continue to pay at least your share of the running and maintenance costs. If the child moves out or dies, however, the property once again forms part of your estate.
It might be easier to downsize and gift the money made to your loved ones instead. Alternatively, equity release on the home might be a solution — though the costs are not as attractive as they were a couple of years ago because of interest rate rises. With equity release you in effect take out a loan or “lifetime mortgage” against some of the equity in your house. It releases capital that you can then gift to your children. On your death the loan has to be settled — usually through the sale of the home.
You will probably lose the family home with this model but, if it helps your children with their finances, releasing their inheritance early, that might be worth the loss — especially if they do not want it anyway.
If you are going to start a gifting strategy, you may want to do it before October 30, when the Budget takes place. But beating the Budget does not necessarily mean you are safe. Tax changes are not usually applied retrospectively but it is possible to imagine new rules — such as lifetime limits on gifts, for example — that could still undermine your well-laid plans. Tax planning is sensible when it matches your family’s goals, but bold decisions motivated purely by potential tax savings have a habit of backfiring.
Yes, find ways to help your children financially — generosity and the “dower principle” can unleash the power of inheritance early when it can have the most benefit. But canny dowagers preserve their own financial security. Take good advice and think carefully — you do not want to live to regret ill-considered death tax arrangements.
Clare Munro is a tax adviser at Weatherbys Private Bank
