Avoid these tax traps – getting a head start on gifting rules and inheritance tax

Gifting is becoming increasingly common. With reasons ranging from helping to buy a first home to simply helping with increased costs of living.

While it can just be a nice gesture, passing wealth across the generations is life-changing for many. However, the process can be complicated and we need to make sure we’re giving them a head start, not landing them with a headache.

This article is not personal advice. If you’re unsure whether a course of action is right for you, ask for financial advice.

Who is helping out?

Those on higher incomes are more than twice as likely to give large gifts (66%). It’s also a reason why almost half of investors have gifted, or plan to gift, more than £5,000 (48%).

Over one-third of retired people said they have given, or plan to give, gifts of £5,000 or more. This is likely to include those who are now keen to use them to help their family and not pay more inheritance tax (IHT) than they need to.

Just under half of parents with children in the household have given gifts of more than £5,000, or plan to do so. This is despite the fact their income is likely to be pulled in more directions while they’re bringing up a family.

Parents seeing the rising cost of living making things tougher for their children, it could mean they’re even more keen to gift.

If you’re thinking about passing on some of your wealth, here are seven ways you can do it to avoid tax traps and gifting glitches.

ISA, pension, and tax rules can change, and any benefits depend on your circumstances. Unlike cash, investments can fall as well as rise in value, so you might not get back what you invest.

This article isn’t personal advice. If you’re not sure what’s right for your circumstances, ask for financial advice.

7 ways to give effectively

1. Use a Junior ISA

Grandparents might be keen to give money away sooner. This is because you don’t pay inheritance tax on any gifts you give if you live for seven years after giving them. This is known as the seven-year rule and applies to anyone, including parents gifting to their children.

However, if they’re wary of giving gifts to those who are under the age of 18, the Junior ISA is a good solution.

In the 2023/24 tax year, you can add up to £9,000 into a Junior ISA for a child, which can be saved or invested tax efficiently. The money can’t be touched until the child reaches 18 and with us, there’s no account charge for Junior ISAs. Any investments you choose may have their own charges.

Find out about the HL Junior ISA

2. Consider a Lifetime ISA

Once children reach 18, it’s possible to super-charge that gift by putting up to £4,000 a year into a Lifetime ISA – within their overall £20,000 annual ISA allowance. Lifetime ISAs are available for people aged 18-39 and contributions can be made up to age 50.

This will be boosted by the 25% government bonus, adding £1,000 for every £4,000. It can then either be used towards buying their first property or for later life. If it’s used for another reason, it will likely be subject to a 25% government withdrawal penalty, meaning they could get back less than originally contributed.

Explore the Lifetime ISA

3. Don’t overlook pensions

If you have an eye on the long term, Junior SIPPs let you put money into a pension for children and get tax relief on it. Despite the fact they’re highly unlikely to be full taxpayers at this stage, they still have the same allowances as an adult. And the earlier you start, the better.

You can’t currently access a pension until age 55 (rising to 57 in 2028).

Explore the Junior SIPP

4. Only give what you can afford

Gifting during your lifetime can be an incredibly useful way to cut your IHT bill. But, make sure you’re not giving away money you’ll end up needing down the line. It won’t help your family if you have given away so much that you need to ask for help later.

5. Consider insurance for potentially exempt transfers

If you give larger gifts, and you don’t live for at least another seven years, they can fall back into your estate for IHT purposes.

It’s worth considering a life insurance policy to cover your entire potential tax liability, including these gifts. This should be written in trust, so it falls outside of your estate, and there’s no IHT to pay on it.

How to protect you and your family

6. Don’t try to beat the system

If you try to give away your home before you die but continue to live in it or benefit from it in any way, it won’t typically be counted as having been given away when it comes to IHT.

While there are a few specific circumstances where this could work, you might have paid for the legalities of swapping ownership without the benefit.

Meanwhile, if you buy into a scheme that puts your home into a trust in an effort to avoid IHT, there’s no guarantee that these schemes will work. The taxman could consider them to be tax avoidance. There are also significant costs to consider.

7. Consider the downsides of any solution that fits within the rules

For example, one solution is if you release equity from your home and spend the money or give it away, it could cut your IHT bill. But you need to factor in the up-front costs and the ongoing interest.

If you give the money away and don’t live for seven years, you could save far less than you expect (under the rules around potentially exempt transfers).

If you live for much longer, you could end up spending more on equity release than your beneficiaries would’ve paid in IHT (because of the interest).

Meanwhile you won’t pay IHT on some investments, like qualifying investments on the Alternative Investment Market. However, not all shares on this market qualify. Those that do will typically be smaller and newer companies, which are high-risk investments.

You should only consider these investments as a small part of a large and diverse portfolio, and only then if they suit your circumstances and you can accept the higher level of risk.

Find out more about gifting allowances and more in our essential guide to inheritance tax.

If you’re not sure what to do, ask for financial advice.

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