Will our adult kids living at home create an IHT bill?

Q: Our adult children live in our house. We pay for all food, utilities, council tax etc, but don’t charge any rent. Is that an inheritance tax liability that should be recorded? It’s covered out of an annual withdrawal we do from our Self-Invested Personal Pensions.

A: It is very generous of you to let your adult children live at home, rent and bill free. 

According to research from comparison site Compare the Market, it costs parents around £280 per month (or £3,400 per year) for children aged 18 to 25 to live at home — hardly an insignificant amount.

• Get our updates on markets, ISA funds, pension saving and much more

It would be understandably painful if that generosity was repaid with a large inheritance tax (IHT) bill upon your death. If your children were living by themselves instead and you were paying their rent and bills, that could potentially be the case. 

In that instance, you might be able to avoid a bill if you were making those payments out of your surplus income and it did not impact your current lifestyle. However, you would need to keep scrupulous records to show HM Revenue & Customs you are legitimately claiming the ‘gifting from surplus income’ IHT allowance.

• Passing on wealth

In this case, they are living with you, and, for IHT purposes, that is a good thing.

Technically, your food bill, utilities, and council tax are part of your regular household expenses. If you spend, say, £500 per month more on food and utilities because you have two adult children living at home, this is simply part of your expenses — and, if £500 is the number, this would naturally reduce the value of your estate by £6,000 per year. This is not a formal IHT gift that needs to be recorded.

• Read: 5 common IHT scenarios - from best to worst

It's the same if an elderly dependant relative were living with you. If they live in the same house, any costs incurred because of their presence (higher food and utility bills, for example) simply count as part of your regular household expenditure. 

But, if you were to try to encourage the chicks to fly the nest by giving them each, say, £50,000 for a house deposit, this does count as a gift, and it becomes relevant for IHT estate calculations. 

From the date you hand over the money, the seven-year IHT clock starts ticking. Should you live another seven years after making the gift, the amount you have gifted falls completely outside of your estate value for IHT tax calculations. But, if you die within seven years of making the gift, that £50,000 will fall back into the value of your estate for IHT purposes.

• Watch: Inheritance tax - What people get wrong about the 7-year rule

Getting the balance right between supporting your children and encouraging them to be financially independent can be hard. Some young people live at home because they simply cannot afford to rent, others have surplus income but simply choose to spend it on other things.

You could try to cultivate good habits among your adult children by telling them they can live at home rent and bill-free so long as they contribute, say, £200 a month towards saving for a house deposit or pay an extra £200 per month into their pension. The amount is far less than paying market-rate rent and would help to set up them financially for life.  

• How to pay for a house deposit in 5 years

Please remember that this is not individual tax advice. IHT is a complicated area of financial planning, so for many people it would be helpful to speak to a specialist tax adviser.

This article was originally published in City AM.

Got a burning question you want to ask? Why not drop us a line. Click here to ask your question.

• Read: 6 money mistakes people make in their 60s
• Read: My five-point investment plan for an unpredictable world
• Read: Pensions shake-up: changes that could reshape your retirement

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.