A guide to gifting

We all want to help our children and grandchildren if we can, but gifting can be complex. In this useful guide, we explore the top ways to give money without falling into a stinging tax net.

The biggest cost-of-living crisis in 60 years has hit younger generations the hardest. Early in their earning trajectory, they are more likely to feel the sting from sharp rises in energy and food bills, while rapidly climbing mortgage rates make it even harder to get on the property ladder.

It's no wonder parents and grandparents are keen to lend a helping hand. Gifts and loans from the Bank of Mum and Dad will total £25 billion between 2022 and 2024, supporting 49% of all first-time-buyer property transactions, according to Savills. Just in the last six months, one in four UK adults have given money to their grandchildren to buy a house, research by LV found.

Those are the lucky ones, however, LV’s study revealed that 80% of recent gifting by grandparents has simply been to help with day-to-day costs or bills. Overall, 35% of retirees have gifted on average £7,000 to their family or friends in the last six months. This rises to £15,000 among those helping grandchildren, with 10% of such donors giving over £50,000.

For many people, being able to share wealth with children or grandchildren is one of the joys of getting older, especially if it's to help with something as life-changing as purchasing a first home. Through these acts of kindness, however, they could be creating an inheritance tax cost for the receiver of the gift and possibly triggering other tax costs such as capital gains and stamp duty land tax for themselves, depending on the type of asset gifted.

“The desire to support children and grandchildren rarely subsides through life and getting on the property ladder is so difficult that if family can help, most will,” says Gill Philpott, Tax and Trust Specialist at Ascot Lloyd. “But most people don’t think about or understand the tax implications. Unfortunately, it's not as simple as just making the gift. You or they could rather suddenly find there is a large tax bill. There are all sorts of rules and limits around gifting, so financial advice is crucial to making the most of gifting and avoiding the traps.”

Legacy tax

Inheritance tax is payable at 40% on the chargeable value of the assets you own and is generally payable by the people you leave your estate to when you die. Lifetime gifting can also impact the inheritance tax payable from your estate. 

However, there are a lot of reliefs and exemptions, which can make gifting confusing. Firstly, there is no inheritance tax chargeable on anything gifted or left to a spouse or civil partner, either during lifetime or on death. The same, unfortunately, is not true for your children or grandchildren.

There are, however, tax-free thresholds, meaning no inheritance tax is due on assets worth under £325,000, and this allowance grows by a further £175,000 if it includes a residential property, though it does taper if the overall estate is worth more than £2 million. If the estate of the first person in a marriage or civil partnership to die is passed in full to their surviving spouse or civil partner, the survivor also inherits their allowances, meaning the total combined allowance is up to £1 million.

No inheritance tax is ever payable on gifts provided to help with the living costs of a child in full-time education or a relative who is dependent because of their age, illness or disability.

And finally, any assets gifted more than seven years before the donor dies are exempt from inheritance tax. But if the donor dies within seven years of the gift, its value will be added to their estate for inheritance tax purposes, albeit the tax if charged will be at a lower rate if they survive at least three years.

Later life financial planning does involve making grim assumptions that while you may not consider death in the next seven years to be likely, it is at least a consideration and increasingly so the older you get. The rules around inheritance tax, therefore, mean that if you expect your estate to be worth more than the thresholds outlined above, and you’d like to make a substantial gift to a child or grandchild, you need to very carefully consider how you go about it.

Property traps

To some, gifting a house may appear a simple solution, reducing the value of your estate while simultaneously helping a child or grandchild onto the property ladder. Yet it’s important to know that if you sell a house to a child for less than its worth, or for nothing, the difference in value still counts as a gift for inheritance tax purposes. You will also have to pay capital gains tax based on the fair market value of the property and possibly stamp duty, as well.

Gifting your own residential home comes with particular risks. While it might avoid capital gains tax costs unless after you’ve gifted the property, you pay rent at the local market rate for use of the property, the value of the property will continue to be included in the estate on death. The rent will need to be paid until death. While paying the rent will mean the value of the property can be removed from your estate after 7 years, there is an income tax cost on the rent. This would be taxable on the recipient of the gift. This is a particularly complex area and advice must always be sought, handing the ownership of your main home to children to save tax comes with other issues to consider, what happens if your child predeceases you or divorces.

One way to make use of your home to reduce the value of your taxable estate, while still retaining ownership is to consider a lifetime mortgage and using the funds to make the gifts to children or grandchildren.

Lifetime gifting and the gift allowance

The simplest way to gift money to children or grandchildren without triggering any inheritance tax charges is by making use of the annual gift allowance. This is currently £3,000, or £6,000 if you didn’t use your allowance last year. The limit hasn’t increased since 1981 when such a sum was enough for a house deposit. Yet while that might not sound like a large amount today, why wait until your children or grandchildren are ready to buy a house before gifting them money?

“It's very wise to plan ahead and make the best use of the exemptions as early as you are able to do so,” says Philpott. “If a child is going to need a house deposit of £30,000 when they get to their 20s or 30s, rather than giving it all in one year you could take advantage of the annual exemption by gifting them £3,000 every year until they are ready to purchase their first home.”

The £3,000 gift allowance is immediately free from inheritance tax, the seven year survival period does not apply.

Junior ISA

Even better, that annual gift could be saved in a Junior ISA, which provides a tax-free wrapper.  The overall limit for Junior ISA contributions is up to £9,000 of savings and investments every year. You can open a Junior ISA for your child or save into one on your grandchild’s behalf. The wonders of compound interest and the opportunity to invest the savings mean the gifted sums could grow to something much larger.

“Junior ISAs are a great place to put gifted money, but you do have to bear in mind that when the child turns 18 they will be in full control of that money,” Philpott says. “People are often fine with that at the start of the process but then later get more reticent about handing over control of a large pot of money to an 18 year old! If that concerns you, you need to explore other options.”

Lifetime ISA

For children or grandchildren aged 18-40, a lifetime ISA can also be a great vehicle through which to channel your tax-exempt gifts, as the government adds a 25% bonus on deposits of up to £4,000 a year. This does, however, only make sense if the recipient uses the money to purchase their first home. Withdrawals for any other purpose will face a tax penalty of 25%.

Children’s pension

Though most people associate pensions with work, a pension can be set up as soon as someone is born. And as any contributions by a parent or grandparent are treated as if they were made by the beneficiary, the tax reliefs are very incentivising. Annual contributions of up to £2,880 net (£3,600 gross) benefit from tax relief and, like Junior ISAs, pensions also offer the tremendous opportunity to invest and over time look to achieve investment growth.

“Pensions offer so many tax advantages through your lifetime,” says Philpott. “It can be a great way to manage inheritance tax, by making gifts into a pension, with the benefit of sharing wealth with an element of control. The pension can't be accessed until the pension member is in their mid-fifties, so they won’t use it to buy their first home, but it does give them a real leg-up on the pension front. If you start at a young age, even if you're only putting in a little bit, a pension pot can grow to quite a large sum, contributing £2,880 per year for 18 years will give a child a pension pot of £64,800, without any growth and take £51,840 out of your estate.”

Trust

For those who want more control over how their gifts are spent but don’t want their children to wait until they’re mid fifties to access the money, a trust is another very good vehicle for gifted assets and reducing the value of your estate. There are a range of different trusts with varying tax incentives depending on factors such as flexibility and control. Trusts can be very complex, with regulations that must be adhered to, so financial advice is vital to approaching them correctly.

Gifting money is complicated in the UK but Ascot Lloyd’s trusted Independent Financial Advisers can help you do it in the most tax-efficient way. Get in touch to find out more.