Inheritance Tax planning is becoming an increasingly important financial consideration for many families. Faced with static nil-rate bands, rising asset values, and forthcoming legislative changes, planning to avoid punitive taxes on death is at the top of the agenda in many financial reviews. Inheritance Tax liabilities can, however, be mitigated through a series of different measures, with gifting being perhaps the most efficient and straightforward way of reducing a potential liability to Inheritance Tax.
Everyone can make capital gifts up to a total of £3,000 per tax year without the value being added to their potential estate. In addition, you can give multiple gifts of up to £250 per person each tax year, provided you have not used another allowance on the same person. Capital gifts above these allowances become Potentially Exempt Transfers, where Inheritance Tax may be payable if you die within seven years of making the gift.
Avoid passing the burden to the generation below
Children are likely to be the most logical recipient of gifts, as it is natural to give assets to the generation below; however, what many donors fail to realise is that their children may, themselves, have an Inheritance Tax problem. This may well be exacerbated once unused pension values are included in estates for Inheritance Tax purposes from April 2027. By gifting funds to their children, they may simply be transferring the Inheritance Tax burden from one generation to another.
As a result, more grandparents are opting to skip a generation and pay gifts directly to grandchildren.
Where the recipient of the gift is below the age of 18, grandparents can fund a Junior Individual Savings Account (ISA) for their grandchildren. A Junior ISA has an annual subscription limit of £9,000 and allows investments to grow tax-efficiently, and as the Junior ISA converts to an ISA once the child reaches the age of 18, funds can remain tax-efficient.
A common concern raised when funding Junior ISAs is the fact that the child automatically gains control of the investment at a time when they may not be mature enough to make sensible financial decisions. Where greater control is preferred, gifts can instead be made into a Discretionary Trust, from where the Trustees can advance capital to the grandchild at a time when funds are needed for a specific purpose, or the Trustees feel the beneficiary will make a responsible decision to spend the funds wisely.
Where grandchildren are older, gifts from grandparents could make a significant difference to a generation who may be grappling with student debt, or budgeting to cope with higher mortgage rates when looking to secure their first home. In addition, by funding a house deposit or paying towards the costs of further education, the grandparent also indirectly helps their children, as this financial need typically coincides at the same time as parents are trying to focus on their own financial security, be it clearing an outstanding mortgage or funding their plans for retirement.
How Grandparents can restructure their investments
Altering existing investment strategies can help optimise the benefit of gifts made to grandchildren in a tax-efficient manner. In addition to the capital gift allowances, gifts out of surplus income can be free from Inheritance Tax from the point the gift is made. There are, however, strict criteria that need to be fulfilled to benefit from this generous tax treatment. The gifts must form part of normal expenditure, and a pattern of regular gifting needs to be established to demonstrate that the gifts are being made from surplus income. In other words, it must leave the donor with sufficient income to maintain their usual standard of living.
Investment strategies that generate an attractive stream of natural income can help provide additional income for gifting purposes. Rearranging Individual Savings Accounts (ISAs) and General Investment Accounts into higher yielding investments, producing a natural income yield of between 4% and 5% per annum, can generate additional income that could potentially be gifted under the gifts out of surplus income rules.
Another planning exercise is to consider taking action with unused pension funds. As pensions are exempt from Inheritance Tax under the current legislation, it has often been sensible advice to leave pensions that are not needed to provide an income in retirement in place, as they would pass without Inheritance Tax applying on death; however, unused pension funds come under the scope of Inheritance Tax from April 2027, and many are considering shifting plans to adjust to the new rules. Firstly, Tax Free Cash can be drawn to fund capital gifts or be placed into Trust for future generations. Alternatively, the pension holder can invest the Tax-Free Cash to produce income that can fund gifts out of surplus income.
In addition to Tax Free Cash, drawing pension income under Flexi-Access Drawdown or an annuity could provide income for gifting purposes. The pension holder does, however, need to consider the income tax implications of generating additional pension income, given their personal financial circumstances.
The benefit of holistic advice
Gifting to grandchildren can help family wealth cascade down through generations. There are, however, decisions that need to be made in respect of the timing of gifts and the best route to ensure that the recipient uses funds appropriately. By actively reviewing the structure of existing investments and pensions, the benefits of gifting can be enhanced and made more tax efficient. Holistic independent financial planning advice can prove invaluable in navigating the range of options available, and our experienced advisers can provide unbiased advice on the most appropriate gifting strategies designed to preserve family wealth. Speak to one of the team to start a conversation.
