Which gifts to family are caught by Inheritance Tax?
Important Information: The value of investments and the income from them can go down as well as up so you may get back less than you invest. Tax treatment depends on individual circumstances and all tax rules may change in the future. You cannot normally access money in a pension until age 55. 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 an authorised financial adviser.
Wanting to give money to children is a natural instinct for many families.
As younger people have struggled to get on the housing ladder many parents and grandparents have made the decision to help them by bringing forward transfers of wealth that would otherwise have been included in inheritance. Others want to contribute to the costs of a wedding, or just make gifts of money that they are still around to see their children and grandchildren enjoy.
Just because a gift happens during life, however, it doesn’t mean that it cannot still be subjected to Inheritance Tax (IHT). The good news is that there are all sorts of exemptions in the rules to allow gifts during life, and some are designed with gifts to children in mind.
Do you need to worry about IHT?
Many people worry about Inheritance Tax but in reality it only falls on a relatively small number of estates. At the last count only 4.6% of estates1 were liable to ‘IHT’ but the total amount of money taken by the tax is rising and hit £5.4bn in 2018/192. Certain groups of people are more exposed, including those owning property in high-value areas, or unmarried people who may not benefit from the more flexible rules for couples.
To work out whether your estate could potentially fall within the scope of the tax, bear in mind that up to £325,000 can be passed on with no IHT due. This is known as the “nil-rate band”. Your estate can include any money held in cash or investments, property and other possessions. Anything over the nil-rate band can potentially face 40% tax.
Anything that is passed to a spouse or civil partner, however, attracts no IHT at all.
Furthermore, spouses and civil partners can pass unused nil-rate band to each other. For example, a husband who dies and passes £100,000 of inheritance to his children would have £225,000 of nil-rate band remaining to pass to his surviving wife, who could then add this to her nil-rate band meaning she could pass on £550,000 without paying any tax.
And there is a further exemption if the estate being passed to a direct descendant (child or grandchild) includes a primary residence - a home in which you live. For 2019/20, this means an extra £150,000 of nil-rate band per person, and this will rise to £175,000 in 2020/21. At that point, these people will enjoy a nil-rate band of £500,000 (to which a spouse's or civil partner's unused nil-rate band can be applied).
A pension can shield your legacy
Following a change in 2015 ‘flexible drawdown’ pension access became a more common way for people to turn their retirement savings into an income.
By keeping savings inside a defined contribution pension using drawdown, retirees can maximise what they pass on to heirs compared to other retirement income options.
Annuities, for example, will typically only provide something to beneficiaries after death if the applicant pays for this extra benefit.
In drawdown, if you die before the age of 75 anything in your pension can be passed on without tax to pay, as long as this is done within two years of the date of death. The money is not normally part of your estate, so no inheritance tax is due when it is paid out from the pension.
Bear in mind that, if you’ve already started accessing your money, anything that you have withdrawn, including the potential 25% of it that is available to you tax-free, would fall inside your estate and therefore be liable for inheritance tax.
For funds still within the pension at death, beneficiaries can withdraw some or all of it, or take an income as if it were their own pension. They don’t have to be of pension age to get the money.
If death occurs after age 75, then the money withdrawn is liable to income tax at the recipient’s marginal rate.
You can find out more about pension income options here.
6 gifts where IHT won’t apply
While the taxman does not allow you to simply give away money to avoid IHT, there are several instances when a gift can be made without the tax being an issue. Tax rules can change so always ensure you are keeping within the rules at the time, and consider professional advice if you are unsure about your liabilities.
The ultimate judgement on whether tax is due is taken after death. The executor of an estate - you can nominate someone yourself - must confirm to HM Revenue & Customs that all due tax has been paid, and the revenue can request proof from them. For that reason, it is important to keep clear records of income during your life, and also of any paperwork concerning gifts that you believe to be exempt from IHT.
If you are relying on these exemptions to make gifts, your executor may have to produce the relevant details, so make it easy for them!
- Gifts under the seven-year rule
You can gift any amount of other assets with no IHT to pay if seven years pass without you dying. If you die within seven years, a reduced rate applies to any amount above your nil-rate band. For this exemption to work, the recipient has to get the full value of the gift. For example, if a property is given by a parent to a child the parent would not be able to continue to live in it. In this scenario, the property is regarded as a ‘gift with reservation of benefit’ and IHT may still apply.
If death happens before three years has passed the full 40% rate applies, then 32% if you die after three years, 25% after four years, 16% after five years and 8% after six years.
- Annual exemption
You can give away £3,000 per year of assets or cash, divided between one or more people, without IHT applying at all. What’s more, you can carry forward one preceding year of annual exemption - so you can gift £6,000 if you haven’t use the exemption from the preceding year.
- Small gifts
You can give £250 per person per year to as many people as you like without IHT applying - although not to someone who has already benefitted from your £3,000 annual allowance.
- Wedding gifts
You can give £1,000 to anyone you like to help pay for their wedding, and this rises to £2,500 for a grandchild and £5,000 for a child. The gift has to happen before the big day, not after, and the wedding has to happen!
- Gift to financially support a child
You are allowed to give money to pay for the living costs of a child under age 18, or in full time education. That includes a child at university, and it may have to be shown that this money was not excessive and only enough to cover living costs and tuition fees.
- Gifts out of your income
You can give regular amounts away that you don’t need from your income, without IHT applying. That means your salary, rents from property, investment and savings income after tax - but not capital itself.
If you use this exemption, it may have to be shown that this money was not needed to ‘maintain your standard of living’. The taxman will look at various things to establish that you have used the exemption appropriately. It will help if these are payments that are made regularly, although that may not mean the same amount every year, or even to the same person. It can be valuable to keep a record (an emailed letter, for example) confirming the level of the payment, that you can afford it from your income and that the payments will be ongoing basis. Your executor may also have to prove your income to HMRC.
1 HM Revenue and Customs 2016-2017
2 HM Revenue and Customs 2018-2019
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