When it’s time to start spending: how to spend your wealth and cut your tax bill

It’s great to save, but there comes a time when it may add little value to your own life and can create tax headaches. Rachel Lacey explains how to manage the shift from saver to spender.

Saving and investing is all about growing your wealth and giving yourself financial security. Savvy investors will spend years siphoning money away, often forgoing spending in the short term, to ensure they don’t have to worry about money in the future.

But for some investors there comes a point that they have achieved the financial security they need. Growing their investments further may add little value to their own life and can create tax headaches – including a hefty inheritance tax (IHT) bill when they die.

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It's for these reasons that financial advisers will often tell some of their older clients to start spending more money. To enjoy the wealth that they have worked hard to accrue.

For people who have spent a lifetime saving, shifting to a spending mindset isn’t necessarily easy. If you’ve prioritised saving over spending until now and you’re not especially materialistic, you’re unlikely to become a ‘shopper’ overnight. But spending more doesn’t have to involve acquiring a lavish champagne lifestyle. There are plenty of ways to spend some of your wealth in a way that can keep your tax bills down and potentially make a real difference to you and your loved ones.

How spending can cut your inheritance tax

• Inheritance tax may be paid by your loved ones if you die with an estate worth more than £325,000 (rising to £500,000 if you are passing on family home). If you are married, you can pass on double this between you before tax will be payable.
• The less money you have in your estate when you die, the lower the tax bill paid by your loved ones.
• Everyone can make some gifts that will be free of IHT. These include a £3,000 annual gifting allowance, wedding gifts, and gifts from regular income. You can also make as many small gifts worth less than £250 as you like. Gifts in excess of these allowance are called potentially exempt transfers, or PETs, and will only be wholly tax free if you live for seven years after making the gift.

Start investing for a child

A Junior ISA can be a great way to get children started with investing. The ISA allowance for children is £9,000 a year – it’s not as generous as the adult allowance, but it’s still more than enough to help them build a meaningful sum when they can access it at age 18. If you’re likely to have an IHT liability when you die, paying money into a grandchild’s Junior ISA each month can be particularly tax-effective. That’s because gifts made from regular income are free of IHT.

If you get in early and start investing when a grandchild is born, a £50 monthly investment would be worth around £17,500 by the time they turn 18 (assuming 5% growth a year and not including charges).

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Alternatively, if you prefer to pay in lump sums, you could give as much as £3,000 away tax-free each year using your IHT annual allowance for gifts.

Celebrate a wedding

If someone close to you is getting married, you can take advantage of additional inheritance tax gifting allowances. You can give up to £5,000 to a child when they get married, £2,500 to a grandchild (or great-grandchild) or £1,000 for anyone else. Your gift could help make their celebrations more affordable or help them get their marriage started on the right financial footing.

Invest in family time

With heating, food and mortgage costs all still rising, it might be harder for some family members to afford catch-ups and get-togethers. Offering to foot the bill for meals out or helping with the cost of breaks together could reduce the size of your estate for inheritance tax purposes, and mean you still get to enjoy quality time with the family.

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Help a loved one get on the property ladder

Increasing numbers of first-time buyers are turning to family to help them take that difficult first step on the property ladder. House price growth might have slowed in recent months, but given it’s largely on the back of rising interest rates, it’s not making it any easier for struggling first-time buyers. But your help might make home ownership achievable. You can give away more than your permitted IHT free allowances each year, but you will need to live for seven years after the gift has been made for it to be totally tax free (after three years the rate of IHT charged is tapered).

Help a favourite cause

Gifts to charities are free of inheritance tax too – and you don’t need to wait until you die to make them either. Gifts made in your lifetime are also eligible.

This exemption also extends to amateur sports clubs and political parties.

The only reason you might not want to leave money to a charity now, rather than later, is if you are planning a hefty donation. If you leave 10% of your estate to charity in your will, you’ll get a discount on the IHT paid on the rest of your estate too, paying 36% rather than 40%.

Enjoy yourself

Giving money away is a core part of inheritance tax planning, but you can still reduce the value of your estate (and subsequently your IHT bill) by spending it on yourself. If this isn’t the time to reward yourself for your hard work, when is?

Spending money on yourself doesn’t have to be about the acquisition of ‘stuff’. If you aren’t comfortable with frivolous expenditure focus on how to get the most out of life and have more enjoyable experiences.

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You might want to do work on your house, invest in a new electric car or upgrade your holiday plans. Alternatively, it could allow you to eat out more, take up new hobbies or spend more time with friends and family.

Get advice if you need it

However financially secure you might feel now, it may well be worth getting financial advice before you spend too much. You might have a significant inheritance tax liability if you died today, but, if you end up needing long-term care, that could change.

It’s important that you don’t spend or give away more than you can afford long term.

Warning: when spending can increase your tax bill

If a desire to spend your wealth brings out the collector in you, it pays to be careful. Investments in antique furniture, art or jewellery, could become subject to capital gains tax if you sell them before you die. If you still own them when you die, they may be subject to IHT.

Only ‘wasting assets’ will be free of CGT. These include items that you would not expect to last more than 50 years, including things like boats, caravans as well as vintage clocks, watches and classic cars.