Handing over cash or property can provide a much-needed boost for grandchildren who are hoping to get on the property ladder or for other relatives and friends who are struggling or trying to look after expensive families. It can also be a legitimate way of reducing your inheritance-tax (IHT) liability.
HMRC raked in a record £4.84 billion in IHT last year, fuelled by growing property prices and an estate threshold – above which you’re liable for 40% tax – that’s remained at £325,000 per person since 2009 (£650,000 for a married couple or civil partners as long as the first person to die leaves their entire estate to their partner).
So here’s everything you need to know about gifting to your family and friends. After all, why should you pay more to the taxman than you have to?
Giving away money
Any gifts between spouses or civil partners living in the UK are exempt from IHT. You can also give up to £3,000 a year to other family members and even friends and acquaintances, without them being liable for IHT – or roll it over to £6,000 in a second year. A married couple giving away cash for the first time could, therefore, hand over £12,000 to a child in one year. After that, their limit would be £6,000 pa.
You can give an additional £250 maximum to any number of other people every year. And parents can give £5,000 to each child if they’re getting married or having a civil ceremony, while the grandparents can chip in £2,500. If you want to give money to anyone else who’s getting hitched, your limit is £1,000.
Gordon and Shirley Muggeridge have used these IHT gifting rules to help their two grown-up sons, while reducing the taxable value of their own wealth. And to mark their granddaughter’s graduation last summer, they gave her £2,000. They also give money for birthdays and Christmas, keeping within the £3,000 limit.
‘We are fortunate to be able to give money to our family and, in any case, saving money at our age is pointless,’ reasons Gordon.
The seven-year rule
It is possible to give children and grandchildren money in excess of the tax-free exemptions. These are known as potentially exempt transfers (PETs). For these not to incur IHT you need to survive for seven years after making the original gift. They include all types of assets – cash, property and shares. However, a PET has to be an outright gift from which you can no longer benefit.
If you die within seven years and the total value of PETs you made in the preceding seven years is less than £325,000, then the amount you gave away will simply reduce your IHT threshold by the same amount. For PETs in excess of £325,000, the amount of IHT due reduces on a sliding scale: if death occurs in less than three years, the usual rate of 40% applies; in three to four years it’s 32%; in four to five years it’s 24%; in five to six years it’s 16%; in six to seven years it’s 8%; in seven or more years it’s 0%.
Over the past 15 years, Christine Jones of Abergavenny has given her daughter sums of money, all of which have now passed the seven-year limit. ‘I was widowed young and wanted to make sure I did what was best for my daughter financially,’ she says. ‘It’s been very beneficial. Forward planning is wise.’
Unlimited cash gifts
There is a way of giving away unlimited cash without falling foul of the seven-year rule – as long as it’s from your surplus income and doesn’t reduce your standard of living or force you to dip into your capital to cover day-to-day costs.
‘If, for example, in previous years you saved £10,000 a year from your income,’ says Patrick Connolly of financial advisers Chase de Vere, ‘you could start gifting this amount to your children each year. For older people with larger incomes this can make a big difference to tax liability.’
HMRC form IHT403 (available from gov.uk) includes a helpful table of possible sources of income and expenditures you should take into account when working out how much surplus income, after tax, you have.
‘Record-keeping is key,’ says Andrew Parry of law firm Irwin Mitchell. ‘A paper trail with details of your income and expenditure will be crucial for your executors to prove that the money given away was money you didn’t need.
‘A letter to the recipient recording that you’re giving them cash from your surplus income and that you intend to make similar gifts in future can also help.’
Informative, in-depth and in the know: get the latest money news with Saga Magazine.
Be charitable and benefit
Gifts to registered charities and political parties are also exempt. Plus, if you leave 10% of your net estate to a qualifying charity, any IHT due on the rest of your estate may be reduced from 40% to 36%.
Passing on your pension
Pension freedom rules, introduced in 2015, mean it’s now possible to pass any proceeds from a defined contribution pension fund to children or grandchildren free of tax – though only if you die before the age of 75. Over that age, your pension provider will deduct income tax, but your beneficiaries won’t have to pay inheritance tax on top.
They could either receive a lump sum on your death or put the money in their own pension pot and receive a regular income when they retire.
‘Inherited drawdown’ allows your beneficiaries to take out as much or as little as they need, when they need it, without waiting until retirement.
‘Know what kind of pension you have, as the rules differ for each – if you aren’t sure, then do check with your provider,’ says Jamie Jenkins, head of pensions strategy at Standard Life. ‘The key thing is to nominate who you would like to benefit – this is completely separate from your will – and to keep that information up-to-date with your pension provider.’
Giving away property
As property prices have soared, IHT now affects thousands of households, even if they don’t have a lot of other assets. But a new allowance for homes was introduced last year to stop families with modest incomes being liable. As well as the normal tax-free threshold of £325,000 each, the new main residence nil-rate band adds another £125,000 each to the tax-free total, if the property is being left to direct descendants, including children, grandchildren, great grandchildren and adopted, step and foster children. This allowance will increase by £25,000 a year until 2020 when it will reach £175,000.
So a married couple with a joint estate of £300,000 and a house worth £600,000 will have a combined £650,000 tax-free threshold, plus £125,000 each of main residence nil-rate band. This gives them a total exemption of £900,000, so their entire estate should be free from IHT.
However, if a couple’s estate is worth more than £2 million, the additional nil-rate band is tapered back down by £1 for every £2 over the £2 million threshold.
Beware gifts with benefits
To reduce IHT bills for those with high-value estates, some might think that signing over their homes to loved ones while they’re still alive would be a clever move under the potentially exempt transfers rules. Indeed, provided you survive the gift by seven years, there’s no IHT to pay. But remember it has to be an outright gift from which you can no longer benefit – you can’t keep living there.
HMRC requested extra IHT from 400 estates last year, seeking a total of £111 million – an average of £277,500 each, from those who’d breached the reservation of benefits rules, according to London law firm Wilsons Solicitors.
If you want to stay in the house, you could pay the new owner rent. However, there’s no need to do this if you give away only part of the property or if the new owners live there, too.
You could take out an equity-release plan and give away the resulting cash. ‘We are doing a lot of these for clients who want their family to benefit from soaring house prices over the years, but don’t want to move,’ says Paula Steele, managing partner of financial advice firm John Lamb. ‘The interest on equity-release plans is payable on death and deducted from the value of your estate.’
Use our equity release calculator to see how much money you could potentially release from your property…
Property other than your main residence
In the case of passing on holiday homes or buy-to-let investment properties with outstanding mortgages, there are other tax implications. Stamp duty would be charged on the sum outstanding on the loan – rather than the value of the property. An additional 3% would be applied to those acquiring second properties if they already owned their own home.
Capital gains tax applies even when gifting a property, not just when selling. ‘Bear in mind the reservation of benefit rules if you continue to use the holiday let, unless you pay rent for the duration of your stay,’ adds Paula Steele. ‘You will need evidence of this – preferably a bank account transfer so it’s in black and white.’
Capital gains tax will also, of course, apply if beneficiaries sell the property. This will be calculated from the date on which the property was gifted rather than the date of your death.
‘Passing on high-value property is riddled with pitfalls,’ says Paula. ‘The residence nil-rate band is unnecessarily complex and can result in extra tax bills.’
‘IHT planning as a whole is complex because of the countless considerations to do with an individual’s wider circumstances, including the size of your estate, your health, what you can afford to give away and more,’ adds Patrick Connolly. ‘Independent financial advice in this matter is crucial.’
Can you give away possessions?
Jewellery, antiques, paintings, stamp collections and other similar items – ‘chattels’ – are all counted as part of your estate for IHT purposes.
If you give them away, they will be exempt from IHT as long as you live for seven years afterwards.
Reservation of benefit rules apply, so if you sign over a valuable diamond ring, you can’t continue to wear it. If your recipient subsequently sells a high-value item, they may have to pay capital gains tax if they make more than £6,000 profit – visit gov.uk and search for ‘capital gains tax and personal possessions’.
The seven-year rule also applies to ‘wasting assets’ – belongings with a predictable life of 50 years or less, which can include classic cars, fine wine and antique clocks. These are exempt from capital gains tax, but this can be a grey area, so do get expert advice.
Enjoyed this article?
You can find more of the same in our Money hub, offering advice, tips and news on all things financial, or you could sign up for our Money newsletter to enjoy more articles like this delivered to your email inbox each week!