Six in ten parents and grandparents intend to pass money on before they die, according to a new report. But giving away money while you are alive could still reward your heirs with a tax bill.
The Openwork Partnership, a financial advisory company, found that the next generation can inherit more than £ 293 billion in total. However, on average, children and grandchildren can look forward to an early inheritance of nearly £ 9,500 each.
Financial gifts like these from parents and grandparents can help young people afford large purchases, such as a security deposit on a house. However, giving away money before you die requires some planning to avoid breaking inheritance tax rules.
Here which one? explains how inheritance tax works and the best way to give money to loved ones before you die.
What is inheritance tax?
Inheritance tax is a tax levied on a person’s wealth – the value of their assets, such as savings, investments, and property, minus any debts.
The estate tax threshold is currently £ 325,000 – also known as the zero rate band.
If your estate is worth more, your heirs must hand over 40% of it to HMRC. Use our inheritance calculator to find out how much they might be billed for.
There is a tax free allowance of £ 175,000 for land containing property as long as property is passed on to a child or grandchild. This means that as an individual you can pass on up to £ 500,000 or up to £ 1 million as part of an inheritance tax-exempt couple.
Which gifts are tax-free?
Giving gifts during your lifetime is the easiest way to avoid inheritance taxes.
There are several ways to pass money on tax-free:
- Annual exemption You can give up to £ 3,000 total each tax year. If you did not use your annual exemption in the previous tax year, you can pass on £ 6,000. However, you can only carry forward the exemption for one tax year.
- Wedding favors Each parent can give their child up to £ 5,000 tax free for a wedding. For grandparents, it’s up to £ 2,500.
- Exemption from small gifts You can also give up to £ 250 tax free to a single recipient as long as the recipient has not benefited from your annual exemption.
- Gifts from the income You can give money to someone by contributing towards their cost of living. However, the pattern of giving must be regular, not sporadic, and it is tax-free only if it comes from free income. So you need to be able to prove to HMRC that the gifts did not affect your standard of living.
For more information, see our guide to planning inheritance tax and tax-free gifts.
What are “potentially exempted transfers”?
The seven-year rule applies to gifts that exceed the annual exemption. So if you die within seven years of receiving the gift, it will be considered part of your estate for inheritance tax reasons.
These are known as “potentially tax-exempt transfers” because they are tax-free if you survive the seven years.
However, if you die within seven years, the amount of tax you will pay will depend on exactly when the gift was given. This is known as the “cone relief”. The longer it has been since the gift was given, the greater the tax break will be:
- Less than three years before death: 40%
- Three to four years before death: 32%
- Four to five years before death: 24%
- Five to six years before death: 16%
- Six to seven years before death: 8%
How else can I give money to a child or grandchild?
You could contribute to a junior Isa. These are tax-free savings accounts for people under the age of 18. Only parents and guardians can open an account, but anyone can deposit up to a maximum of £ 9,000 during the 2021-22 tax year.
When the Junior Isa Allowance runs out, consider buying premium bonds for your child or grandchild. Premium bonds do not pay interest, but there is an opportunity to win prizes up to £ 1 million per month that are tax exempt.
You can also take out a pension for your child or grandchild. Your contribution would benefit from tax breaks. However, the child will not reap the benefits of the gift until they are older – and may prefer to contribute to more urgent expenses such as a wedding or a house deposit.
Another option is to establish a trust relationship. This can be a great way to secure your savings until the child or grandchild comes of age. However, the rules for inheritance taxes and trusts are complicated. So read our guide on the matter.
Make a will to set out your plans
Whichever way you choose to distribute your estate, it pays to start planning early and then state your wishes in your will.
Without a will, your estate will be distributed according to intestacy rules and your loved ones could end up paying more inheritance tax than they need to be.
- Are you making a will If you would like assistance, you can hand in your will and have it from Which? Wills, and until April 30, 2021 it’s half price.
