A new government has just been installed in Westminster, inflation appears to be under control and we’ve just seen the first cut in interest rates since March 2020. But for many young people, studying, getting married and getting onto the property ladder are still beyond their reach.
The bulk of your wealth will most likely be passed on to your children when you die. But more often than not, this wealth is needed far earlier on. So you may want to consider ways of gifting money to them while you are still alive.
Increasingly reliant as they are on older family members for help with “big-ticket items”, there is a risk that HMRC might get its hands on a significant chunk of any gifts they might receive.
This week, Wealth Manager Jack Ingamells talks you through the fiscal implications of the various options available so you can gift in a tax-efficient way.
You can give money to your children relatively straightforwardly. But there could be inheritance tax (IHT) implications. Any money you give could eat into your “nil rate band” – the threshold below which the value of the gift or estate is subject to zero inheritance tax in the UK.
But there is some leeway with this and some options you may wish to consider.
Everybody has an annual exemption of £3000 per tax year. And up to two years’ worth of exemptions can be accumulated. So you can gift up to £6000 without there being any IHT implications. Combine this with your spouse’s allowance… and the two of you together could gift your child £12,000, completely tax-free.
You can give up to £250 away per person to as many people as you wish in any given tax year. However, you may not use your entire annual exemption and your small gift allowance on the same person.
You can give away certain amounts as wedding presents, provided that you do not exceed certain limitations. Your children can get up to £5000, and your grandchildren up to £2500 when they marry. You can also give away up to £1000 to non-relatives. Any amounts you give away can be boosted by using your annual exemption allowance (which can be split across several people). And then there are “gifts out of surplus income”, which we will discuss below.
HMRC defines surplus income as income that is not required to maintain your standard of living. If you have any such income in the year–income that is surplus to your needs – you are free to give it away… and it will be completely exempt from IHT. It can be in the form of earnings, pension income, income from investments, interest on – say – cash in a bank… but not the proceeds from the sale of a house (for example). Any such gifts must be made out of your income, and it must be possible to demonstrate that they form part of your “normal expenditure” and are paid out on a regular basis (which is why it might be a good idea to set up a standing order). When used in conjunction with your £3000 annual exemption, they can be an effective way of moving money away from your estate over a period of time.
Keeping sound records of gifts you make is extremely important. Being able to demonstrate that you gift on a regular basis and that these gifts were made out of surplus income could prove extremely helpful (for your children or solicitors having to deal with probate after your death for example).
Broadly speaking, any gifts you make are exempt from IHT if you live for seven years after you have given them. However, should you die within seven years of gifting money and there is IHT to pay on the amount you gifted, the amount due will depend on when exactly you gave any gifts that are not covered by the exemptions it.
There is a distinction to be made between Chargeable Lifetime Transfers – which are usually gifts made into a discretionary trust and which immediately incur a 20% payment to IHT on anything over the nilrate band (£325,000), and Potentially Exempt Transfers – which are not immediately chargeable to IHT, but which reduce the donor’s amount of available nil rate band by the amount of the gift (less the available annual allowance).
For the purpose of this article, we will focus on Potentially Exempt Transfers. Once 7 years have passed following a potentially Exempt Transfer and assuming the donor has not passed away during this time, the nil rate band is reset and the gift is exempt from IHT altogether. If the donor died within 7 years, then the gift itself will not be subject to IHT if the value was within the nil rate band (i.e. under £325,000), although, the nil rate band is reduced by this amount. This is essentially an IHT charge as it pushes other assets in the estate out of the nil rate band, meaning they will be subject to 40% IHT. If the gift exceeded the value of the nil rate band, or if there were other gifts and the total value exceeded the nil rate band, then tax will be payable at 40% on the proportion of the gift over the nil rate band, with the most recent gift being the first in the firing line, as long as the gift was made within 3 years of death. Gifts made 3 to 7 years before death are subject to taper relief which is detailed in the table below:
Something you might wish to consider as a way of protecting your beneficiaries against any potential inheritance tax liability on a gift they have received is a Gift Inter Vivos life assurance plan. Such a policy would provide a lump sum to cover the potential IHT liability or loss of the nil rate band that could arise should you die before the end of the seven-year period.
Inheritance tax is not the only thing to watch out for when gifting money to your children: you should also consider capital gains tax and income tax.
Under normal circumstances, there are no tax liabilities associated with cash gifts. However, if you are selling assets to generate required cash (or even gifting the assets in question), then you may incur a CGT liability.
The annual CGT allowance has recently been halved to £3000,making a tax liability more likely than was previously the case.
There are a number of other ways to gift money to your children while they are young – such as paying into a Junior ISA (if they are under 18) or a savings account on their behalf. But do bear in mind that if you invest money into a savings account for your child and those savings generate more than £100 interest annually, then you – the parent – will be liable for thattax (not your child). For more insights, have a look at our article on wealth-building strategies for young people or our article on encouraging financial literacy in young people.
The last government did indeed consider abolishing inheritance tax. But it looks set to stay for the foreseeable future. So if you want to gift money to your children in as tax-efficient a way as possible,consider a number of things:
Whether it be utilising trusts, taking out a gift inter vivos policy or running through a checklist of all available allowances, we can help with all areas of legacy planning, so that you or your loved ones won’t be hard hit by the taxman as a result of helping them with some of life’s big-ticket items.
