Christmas is a time for giving, and many parents and grandparents will want to use this opportunity to gift cash sums to younger relatives. Giving cash to children and grandchildren not only allows them to treat themselves to what they want, but it can also help to improve their financial stability, pay off student loans, or even get them on the property ladder.
However, unless you take steps to protect these gifts from tax, the recipients may end up with an IHT liability later down the line. For some people, gifting needs to be carefully planned to make use of all the available tax exemptions and allowances. Here are some of the rules you need to know.
Inheritance tax can apply to lifetime gifts
Many people think of inheritance tax as a tax on the value of your estate at the time of your death. In fact, your estate may also include money and assets you gave as gifts in the seven years before your death. Meaning that, if you were to give substantial financial gifts and die unexpectedly – even years later – you could create an inheritance tax liability.
Recent government figures show that the government collected £3.2 billion in IHT between April and August this year. It’s natural to want to minimise the IHT bill your family is left with after you’re gone, and fortunately, the government allows various ways to do this.
Certain gifts can be made free of inheritance tax
We can never know for sure when we’re going to pass. So, if you want to avoid unexpected IHT charges, you should stick to gifts which are IHT-exempt. Your options include:
- Gifts within your annual exemption
You can use your annual exemption to give away up to £3,000 every year and be sure that this won’t be included in the value of your estate for inheritance tax purposes. This allowance can be carried forward to the following year if it is unused.
- Small gifts
Any gifts of less than £250 are immediately excluded from your estate. There’s no limit on the number of people you can give these small gifts to, although they can’t be the same people you’ve made gifts to using other exemptions.
- Gifts from surplus income
Gifts made from surplus income are exempt from IHT. To qualify under this rule, the gift must be made as part of a regular pattern of gifting (annual Christmas gifting included) and must be made from your income (not from capital), without reducing your standard of living and affecting your lifestyle.
For example, an individual with £5,000 of surplus income from their pension every year, once their living costs are covered, might establish a regular pattern of gifting this money at Christmas.
- Gifts to charity
Any gifts to charity are also exempt from IHT. Plus, if you leave 10% or more of your entire estate to charity, IHT will be charged at a lower-than-usual rate (36% rather than 40%) on the relevant portion of your estate.
Gifts into ISAs have another level of protection
Inheritance tax is not the only tax to be aware of when you’re making financial gifts. You should also consider that, as your gift grows through interest or investment returns, this growth can be subject to income tax, dividends tax, or capital gains tax.
You can protect the recipient from the effect of these taxes by paying into a tax-efficient wrapper, such as an ISA. Your own ISA allowance will be unaffected by the gift, but you’ll need to be sure not to exceed the recipient’s annual allowance. For this tax year, all UK residents over 16 have an ISA allowance of £20,000.
If the recipient is a minor (under 18), you can contribute to a Junior ISA (JISA) on their behalf. This type of account can only be opened by a parent or guardian, but grandparents (and anyone else) can also pay in. The limit on contributions is £9,000 per year. Minors aged 16 or 17 can have both a cash ISA and a JISA, with a combined annual allowance of £29,000.
Trusts also have tax advantages
A bare trust (also known as an absolute trust) is another way to pass on money to minors. Unlike a JISA, there’s no limit on how much you place in trust. While a trust doesn’t offer the same tax protection as a JISA, the contents of the trust are taxed as if they belong to the child, meaning there is often little or no tax to pay.
However, money placed in trust is not necessarily protected from inheritance tax. The rules and laws around trusts are very complicated, so you should discuss this option with a financial adviser before proceeding, to make sure it’s right for your circumstances.
Give gifts that keep on giving
Unlike the latest toys and gadgets, cash gifts can contribute to the ongoing financial security of your loved ones. Plus, by giving the money in your lifetime, you’ll get to see them enjoying it instead of waiting to inherit it.
Distributing your wealth without falling foul of the complex inheritance tax rules can be tricky, and the best way to do it depends on a variety of factors, including the size of your estate, the people you’d like to make gifts to, and how much you want to give away.
At Investec Wealth & Investment, we work closely with our clients to discuss their wishes and put plans in place to help ensure that these wishes can be fulfilled. Our relationship-based approach to financial planning and investment management aims to make a tangible and meaningful difference to clients and their families.
If you’d like to start a conversation about inheritance tax planning or any area of your finances, get in touch with your local Investec Wealth & Investment office for a complimentary, no-obligation conversation.
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