It is possible to give a gift of up to £3,000 every year tax-free
Other allowances also enable you to make gifts tax efficiently
It is best to plan how you will make gifts as early as possible
Many parents and grandparents want to help younger generations of the family with costs such as university fees or a deposit for a first home. But passing on the substantial sums necessary can result in hefty tax bills.
It is possible to give a gift of up to £3,000 every year tax-free, but if you give anything above that and die within seven years the person receiving it is potentially liable to inheritance tax (IHT). If this falls within your £325,000 IHT allowance then the person receiving it should not incur tax. But it reduces your IHT allowance by however much you have given, so reduces your capacity to pass assets tax efficiently in future.
Further tax efficient gifts
If you have not used the annual £3,000 gift allowance in the prior year you can carry it over so you could potentially gift £6,000 in one year.
If your child is getting married you can give them £5,000, and if your grandchild or great grandchild is getting married £2,500.
You can also make gifts out of regular income if you do not need all of your income and can maintain your standard of living after making the gift. But it is very important not to give away more than you can afford and go short of money in your retirement, as you cannot get the money back.
“Don’t gift away too much too early,” says Svenja Keller, head of wealth planning at Killik & Co. “Make sure you can have the lifestyle you want and, for example, pay for later life care. Don’t do it if can’t afford to.”
Graham Angell, product proposition director at The Openwork Partnership, suggests carefully working out what you afford to give to beneficiaries, by analysing your income and expenditure.
You should also keep a record of making the gifts as evidence may be required when tax liabilities are calculated after your death. This could be as simple as a note or spread sheet showing how much you gave and when. Angell suggests keeping this with your will.
Excess income could be put into a Junior individual savings account (Isa), into which you can put up to £9,000 in the current tax year. However, the child gets control of the money when they are 18 to spend how they want rather than perhaps how you intended. Even if you trust your children or grandchildren to spend it as you intend, this might not be the case with their future partners. And if your child or grandchild gets divorced some of what you gave them could go to their former spouse in any settlement.
To have more control over what you gift, one option would be to hold the money yourself and pay, for example, the house deposit or university costs on the child’s behalf at the time required. But this would still fall into your estate over and above any exemptions if you did not survive for seven years after doing it. And waiting rather than making regular gifts from an earlier date would mean that you do not reduce your taxable estate a little each year.
If the money is not required for an expense earlier on such as university costs or a house deposit it could be put into a child’s pension which, like an Isa, is a tax efficient environment in which to hold it. Up to £2,880 plus tax relief at 20 per cent - £3,600 in total - can be put into a child’s pension each year. This enables the child to get a head start in saving for retirement as, with many financial obligations in the earlier part of life, it can be difficult to save much for retirement. But the child is unlikely to be able to access this until age 57 or older.
If you have an adult child you could pay into their pension. This can be particularly effective if they have children, and lose some or all of their child benefit due to having a salary over £50,000. If either parent of a child earns between £50,000 and £60,000 per year before tax they have to pay back some of their child benefit as extra income tax. You have to pay back 1 per cent of your family’s Child Benefit for every extra £100 you earn over £50,000 each year. If either parent of a child earns over £60,000 per year before tax they have to pay back all of the child benefit as income tax.
But a contribution into an adult child’s pension is counted as if that child made it and reduces their net income. If this brings their salary down to £50,000 or less per year they would not lose child benefit plus their pension pot would be boosted.
If you die within three years of giving a gift worth over £3,000 that is not covered by one of the allowances set out above or which falls within your £325,000 IHT allowance, the person receiving it pays tax at 40 per cent. If you die within three to seven years of making the gift not covered by those exemptions it incurs tax at the rates set out in the table.
|Tax to pay if you die within seven years of making a gift not covered by allowances|
|Years between gift and death||Tax paid (%)|
|Less than 3||40|
|3 to 4||32|
|4 to 5||24|
|5 to 6||16|
|6 to 7||8|
|7 or more||0|
If you survive for seven years after making a gift the recipient will not incur IHT. Angell suggests that if you make large gifts that are not covered by any exemptions the earlier you do it, the better, because you are more likely to survive for seven years than when you are older.
If you do not want to risk your heirs paying tax on gifts that could potentially incur IHT you could make provision in your will for it to be paid out of your estate, as set out in the example below.
Keller also suggests giving the money directly to your grandchildren if it is ultimately for them rather than via your children. This is because it would mean just potentially paying IHT once rather than twice – when you die, rather than when you die and again when your children die.
Trusts can be a tax efficient way to pass on assets, but can be expensive to set up and still incur tax. So it is probably best to exhaust one of a number of other options before resorting to these. You can read our guide on the different types of trusts and their uses in the issue of 2 October or at https://www.investorschronicle.co.uk/managing-your-money/2020/09/30/tax-planning-and-the-role-of-trusts/.
<Box out> How to cover your heirs IHT on large gifts
David and Sarah want to pass £200,000 to each of John and Julie when they reach age 21.
David gives £200,000 to John in 2019 and £200,000 to Julie in 2020.
David dies in 2021 so the gifts which were potentially exempt transfers will be chargeable and assessed versus his £325,000 nil rate band.
The first gift to John uses up £200,000 of David’s IHT allowance band but the second, to Julie, is only offset by the remaining £125,000 of David’s IHT allowance. So £75,000 of Julie’s gift is subject to IHT at 40 per cent and Julie is potentially liable to pay £30,000. This means that she would only retain £170,000 of the intended £200,000 gift.
But if David’s will says that this charge should be covered out of his estate then Julie does not have to pay it.
Source: Graham Angell, The Openwork Partnership