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How to give money to the younger generation, not the taxman

31st May 2024
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Saving tax isn’t necessarily the core motivation when passing wealth down the family line, but it’s an important consideration

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Whether it’s student debts, getting on to the property ladder, or even staying on it, there are numerous financial challenges facing younger generations.

But while older people haven’t necessarily been immune to rising costs, the intergenerational wealth gap means many are finding themselves in a position to help younger family members. In fact, figures from the Resolution Foundation in 2022 showed that between 2018 and 2020, 51% of our personal wealth was in the accounts of the over-65s, a figure that has shot up from 42% between 2006 and 2008.

And the findings of ii’s own Great British Retirement Survey show that many older people are keen to support their families financially, with 27% of respondents saying that they had helped children with a house deposit. Over the past three years, 15% of over-65s who took part in the survey also said that they had given a “living inheritance” to loved ones.

It’s widely acknowledged that helping people – financially or otherwise – makes you feel good, and that was borne out in the survey too. When asked why they gifted the money, some 40% said that they simply wanted to enjoy seeing their loved ones benefit from the gift.

There is also often a strong desire to solve a problem for a family member. A third (32%) wanted to help with rising living costs.

The issue of inheritance tax (IHT) and reducing a potential tax bill, however, was very much on the back-burner, being the motivation for just 24% of respondents.

But, even if you aren’t being motivated by tax, if you are giving money to loved ones and are likely to face an IHT liability, it still makes sense to ensure those gifts are as tax effective as possible.

Without proper planning or record keeping, you could miss out on the opportunity to save your loved ones a 40% tax bill.

Gifting lump sums

Each year you can give away up to £3,000 free of IHT and, if you didn’t use last year’s allowance you can carry that forward too. That means a couple that hasn’t gifted before could give away as much as £12,000 in one go.

If you have a child that is getting married you can also give them up to £5,000 tax free too to mark the occasion (or £2,500 for grandchildren) – helpful if they are planning on buying their first marital home.

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Tips on gifting and inheritance tax

But, if you want to give away more than is permitted by these allowances, a bit more planning can help to ensure you don’t pay any unnecessary IHT.

Gifts over the allowances are known as potentially exempt transfers (PETs). The IHT payable on these gifts reduces over time – only becoming totally tax free if you survive seven years after making the gift.

Depending on your age and health, this means you might want to consider the timing of larger gifts.

It’s also important that the executor of your will knows about these gifts. This is because they will be responsible for valuing your estate and paying your IHT bill and, any gifts you made during the last seven years of your life, will need to be declared as part of that process.

You can do this by keeping a record of your gifts, which your executor will know where to find when the time comes.

The record should include the date and value of the gift as well as your relationship to the person receiving it.

Giving money your way

Lump sum gifts can provide a great way of helping children with certain financial challenges, such as buying a home or perhaps renovating an existing one. But often intergenerational wealth transfer doesn’t work in this way, with money often being drip fed down to loved ones over time, rather than handed over in big dramatic gestures.

For example, you might be helping family by footing the bill for your grandchildren’s weekly music lessons, chipping in for the monthly mortgage, if rising interest rates mean their bills have shot up, or paying the rent for any students at university.

Alternatively, you could support your work-frazzled kids with a weekly cleaner.

These gifts are unlikely to require big lump sums and in many cases, you’ll be making them from your spare income.

But these gifts can still be tax effective. And if you are making them regularly over a lengthy period - they have the potential to take a sizeable chunk out of your taxable estate and reduce your IHT bill.

Gifts from regular income

While many people are aware of the rules around passing down lump sums, the gifts from regular income exemption is massively underused.

Under current rules, gifts made out of your regular income are IHT free and, unlike lump sum gifts, there aren’t any limits.

So, paying £500 towards your child’s mortgage, for a year, for example, would get £6,000 out of your estate and potentially save £2,400 in tax. Alternatively, £25 a week on music lessons for five years, would net the same saving.

However, as is often the case, there is a catch. To get IHT relief, the gifts need to be made out of surplus income and must not have an impact on your standard of living. 

This means that, when the time comes, your executor will need to show HMRC that the gifts were regular, covered by your normal expenditure (rather than coming from savings or investment plans) and that your generosity did not impinge on your lifestyle.

As such, to ensure you’re spared IHT, your record keeping needs to be top notch.

In addition to information around the size of the gifts, the dates they were made and who received the money, you’ll also have to include information about your income and expenditure for the relevant tax years.

Your income details should include everything you get from pensions or earnings, rent, savings and investments. You should also state how much income tax you paid too.

The information you provide on your expenditure needs to be equally comprehensive, detailing how much you spend on holidays, entertainment and eating out, as well as the money you need to cover your regular bills.

The difference between your income and expenditure needs to be enough to cover the cost of your gifting for every tax year you are making them.

Ensuring your gifts are tax-effective can be a bit of an admin headache, especially when they are being made from your income. But if any help you are giving to your family while you are alive can also bring them tax savings when you die, it has to be worth the effort.

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