Saving on tax might not be the main motivation when transferring wealth to the next generation, but it's certainly an important consideration.
The younger generation faces numerous financial challenges, such as student debt and the difficulty of getting on or staying on the property ladder. While older generations also experience rising costs, the wealth gap means many older individuals are in a position to help their younger family members. According to the Resolution Foundation in 2022, 51% of personal wealth was held by those over 65 between 2018 and 2020, up from 42% between 2006 and 2008.
Findings from ii’s Great British Retirement Survey reveal that many older people are keen to provide financial support to their families, with 27% of respondents helping with house deposits. Additionally, 15% of over-65s reported giving a “living inheritance” in the past three years. Helping others financially is known to bring a sense of satisfaction, a sentiment echoed by 40% of survey respondents who enjoyed seeing their loved ones benefit from their gifts. Furthermore, 32% aimed to alleviate rising living costs for their families.
While inheritance tax (IHT) wasn’t the primary motivation for most respondents, with only 24% considering it, it remains prudent to ensure financial gifts are tax-effective to avoid unnecessary taxes. Without proper planning and record-keeping, loved ones might face a 40% tax bill.
Gifting Lump Sums
Annually, you can give away up to £3,000 free of IHT, and if you didn't use last year’s allowance, you can carry it forward. This means a couple that hasn’t gifted before could give away up to £12,000 in one go. For a child getting married, you can give up to £5,000 tax-free, or £2,500 for grandchildren, which can be useful for buying their first home.
Tips on Gifting and Inheritance Tax
Exceeding these allowances requires careful planning to avoid unnecessary IHT. Gifts beyond the allowances are known as potentially exempt transfers (PETs), and the IHT on these gifts decreases over time, becoming completely tax-free if you live seven years after making the gift. Considering the timing of larger gifts is essential, especially based on your age and health.
Executors of your will must be informed about these gifts, as they will need to declare them for estate valuation and IHT calculation. Keeping detailed records of your gifts, including dates, values, and the recipients’ relationship to you, is crucial.
Giving Money Your Way
Lump sum gifts can address significant financial challenges, such as buying a home. However, intergenerational wealth transfer often occurs gradually, with smaller, regular contributions. For instance, you might help with your grandchildren’s music lessons, contribute to monthly mortgage payments, or cover university rent. Supporting your children with a weekly cleaner is another example. These smaller, regular gifts, often made from spare income, can also be tax-effective and reduce your IHT bill.
Gifts from Regular Income
The exemption for gifts from regular income is underutilised. Under current rules, these gifts are IHT-free and have no limits, provided they come from surplus income without affecting your standard of living. For example, paying £500 towards a child’s mortgage for a year removes £6,000 from your estate, potentially saving £2,400 in tax. Paying £25 weekly for music lessons for five years achieves similar savings.
To claim IHT relief, your executor must demonstrate to HMRC that the gifts were regular and did not affect your standard of living. Detailed records of income, expenditure, and the gifts are necessary to prove this. Income details should include all sources, such as pensions, earnings, rent, savings, and investments, along with income tax paid. Expenditure records should cover holidays, entertainment, dining out, and regular bills.
Ensuring your gifts are tax-effective can be administratively challenging, especially when made from income. However, the effort is worthwhile if it can save your family tax when you die.
These articles are for informational purposes only and do not constitute personalised financial advice. Investments can go down as well as up, and you may not get back the amount invested. Always seek advice from a qualified investment adviser if in doubt.
Source: Interactive Investor
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