Downsizing will free up £2m. Now to decide what we do with it

Q. We are in the process of downsizing and are likely to suddenly have about £2 million available to invest, though we plan to pass some of it on to our three children. We will top up our Isas and Premium Bonds but what recommendations would you have for the remainder?Robert, 73

It can be tempting to make large and generous gifts on receipt of a lump sum, but do make sure you are financially secure yourself before making any irreversible contributions. Ensure you have enough cash set aside in an easily accessible rainy day savings account, as well as cash to cover any forthcoming expenditures such as a new car, home renovations or care costs. Asking a financial adviser for a cashflow forecast would be a good way to determine how much could be gifted without having a detrimental impact on your own finances.

Gifting

Based on current inheritance tax rules, there is an argument for making planned gifts sooner rather than later. When seven years have passed, these gifts should no longer be liable for inheritance tax. But we cannot rule out some changes to this legislation in the budget in October, so there is also an argument for waiting until then to find out what the new rules of the game will be.

Gifting to grandchildren as well as children may also be worth considering, because skipping a generation could potentially avoid a layer of inheritance tax. Junior Isas (Jisas) are a tax efficient vehicle for the under-18s and are a great option for grandchildren. These must be opened by a parent but they then can be contributed to by anyone, including grandparents.

You can put £9,000 a year into a Jisa, the money can be invested and there will be no tax on dividends or capital gains. When the child turns 18, the account will become an adult Isa and the investments will remain free of tax.

Business relief

It sounds as though your children are a part of your financial plan and therefore inheritance tax is probably a key consideration for your investments. Certain shares on the UK’s AIM market are eligible for business relief, which means they will not be liable for inheritance tax if they are held for at least two years.

Many investment houses offer dedicated services for clients interested in business relief for inheritance tax purposes. However, it is worth noting that this is not a strategy for the faint hearted. UK shares have been out of favour since Brexit, and smaller companies have been out of favour since interest rates rose in 2021. The AIM index, featuring companies that are small and based in the UK, has lost more than 40 per cent of its value since its 2021 peak. Time will tell if interest rate cuts in the UK will inject some life back into the index.

Tax efficiency

Isas offer fantastic flexibility and tax efficiency, so you are absolutely right to top these up this year and should keep doing so in future years.

Savers under the age of 75 who are not earning can contribute £2,880 to a pension each year and receive a basic tax rebate that will increase the contribution to £3,600. An added benefit is that defined contribution pensions — where a pot is based on how much you pay in — are currently not liable for inheritance tax.

Other tax-efficient vehicles include trusts and offshore bonds. These are more complex and therefore more costly and, given their complexity, formal advice should always be taken where either of these are concerned.

Given your large cash sum, you won’t be able to invest or save it all in Isas and Premium Bonds. So bear in mind that some investments are more tax efficient than others.

For example, bond funds — a collection of bonds managed by a dedicated fund manager — are subject to capital gains tax, whereas qualifying individual bonds — a loan from an investor to a borrower — are not. This distinction is particularly important at the moment, given that bond prices typically rise as interest rates fall.

Phased investment

Placing a large amount of cash into the market can be a daunting prospect, but purchasing the investments gradually over a number of weeks should ensure a smoother ride.

We would usually deploy new cash over a period of three months, with the speed of deployment being adjusted based on market performance. For example, an unexpected drop in the market may present an opportunity to invest more quickly.