Mark Williams looks at how advisers can help their clients manage the risks involved in estate planning.
As investors become older, they tend to narrow their risk horizons. It may be that they no longer want exposure to ‘risky' assets such as emerging market equities or high-yield debt. But this does not mean that risk is less of an issue.
In fact, a whole new array of risk considerations come into play when investors reach their later years.
Any financial decision involves risk, and in old age the landscape is complicated by considerations of health, longevity and family circumstances.
It seems counter-intuitive to talk of the ‘risk' of living to 100, for example - surely a long life is something we'd all be happy about. Yet when planning post-retirement finances, it's a possibility that needs to be front-of-mind.
So, what are the key risks that advisers need to discuss with their clients as they come up with plans for making best use of their wealth in their remaining years and for the following generations?
The seven-year hitch
Gifting is a popular choice with many older investors. Passing wealth on can be personally satisfying and it may ensure the money is not subject to inheritance tax.
The key tax risk, of course, is that the donor may die in the seven years after making the gift - in which case the value of the gift is included in their estate.
However, a full picture of risk would also include the possibility that a child may squander the money or that half of it could pass out of the family because of a marital breakdown.
Healthy investors in their mid-60s may be ready to brush off the possibility of death in the next seven years, but the fact that they will have no say in how their money is spent could strike them as a more pressing risk.
And, of course, the irrevocability of a gift or trust also entails considerable risk - what if the money that is given away or put into trust is then needed later on for, say, long-term care?
The BPR alternative
Investments based on business property relief (BPR) offer a flexible alternative to gifts and trusts.
Once an investor has had shares in BPR-qualifying companies for two years, they will be exempt from inheritance tax, as long as they still own them at the time of their death.
The investor retains ownership of the shares and can have access to the money, assuming the shares are liquid.
However, as the risk focus moves away from access and control, it moves onto the investments themselves. In other words, clients have to think hard about how their money is invested.
BPR-qualifying shares must be unquoted (this includes those on AIM), and the risks of each company must be assessed on its particular merits.
At one end of the spectrum there will be growth-oriented businesses, perhaps listed on AIM, that come with a risk of short-term movements in capital value.
At the other end, there may be companies that are managed specifically for their BPR potential and focus on capital preservation.
Investors may be more comfortable balancing this type of risk than dealing with questions about whether they will live for another seven years.
They may feel the potential rewards are clearer too. This could be good news for investors expecting to enjoy 15 or even 20 years of retirement, who are unwilling to give up the potential of long-term investment growth potential, either for themselves or for a future generation.
Naturally, when choosing a BPR vehicle for estate planning, there are also risks involved in the choice of investment manager. Again, the investor, may take some comfort from the fact that risks of this type can be managed in a way that considerations about family and health cannot.
Their adviser is on hand to help them identify a manager with a good track record and reputation for excellent service - who may even, for example, align their interests with those of the investor by deferring their fees and making them contingent on achieving targeted returns.
They will also be able to look ‘under the bonnet' together and check that their BPR investments offer the level of diversification they are looking for.
Mark Williams is business line manager for inheritance tax products at Octopus Investments
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