How to beat inheritance tax by gifting to your grandkids

This year inheritance tax (IHT) receipts from April to July were £2.8bn – £200m higher than the same period last year.

This is partly thanks to frozen IHT thresholds and rising asset values.

And now there are even rumours the government could change IHT rules in the upcoming Autumn Budget to bring even more tax revenue in.

How does IHT work?

IHT is usually paid at 40% on the value of an estate over the £325,000 allowance. There’s an additional allowance of up to £175,000 if you pass on your family home to children or grandchildren.

If you’re married or in a civil partnership, you might be able to pass on up to £650,000 – or up to £1mn when passing the family home to children or grandchildren.

Can gifting reduce your IHT bill?

Many will want to pass on gifts to their grandchildren to help them secure their financial futures.

If you’re looking to give money to your grandchildren, making gifts now could mean those gifts will be free or exempt from tax.

Here are some of the IHT exemptions.

This isn’t personal advice. Tax rules can change, and their benefits depend on your and the child’s circumstances. If you’re not sure what’s right for you or a child, ask for financial advice.

Inheritance tax exemptions

Annual exemption

You can normally give away up to £3,000 per tax year inheritance tax free. This is known as the annual exemption. You can carry any unused annual exemption over to the next tax year. But if you don't use it in that year, it’s lost.

For example, if you used £2,000 of your annual exempt amount in the last tax year, you could then gift £3,000 for the current tax year, and £1,000 carried over, a total of £4,000.

Small gifts

On top of the annual exemption is a small gifts exemption.

This lets you give up to £250 each to any number of recipients each tax year, although not to anyone who received a gift that came under any of the other exemptions.

However, you can't give more than £250 and claim the first £250 as a small gift. If you give an amount greater than £250, the exemption won’t apply. Wedding or civil ceremony gifts are exempt up to £5,000 for a child, £2,500 for a grand-child and £1,000 for other loved ones.

Gifts out of income

You can also make 'gifts out of income' free from inheritance tax.

Regular payments made out of excess income (which don't affect your standard of living) are normally exempt from IHT.

This can be a useful exemption for those wanting to contribute to a child’s investments through regular savings.

It’s important to keep records. If you decide to make regular gifts out of income as part of your normal spending, you should keep a record of your after-tax income. This will demonstrate the gifts you've made are regular and you have enough income to cover them and your usual day-to-day costs, without having to draw on your capital.

Potentially exempt gifts

If any gifts you make to individuals don’t qualify for an exemption, they’re usually classified as Potentially Exempt Transfers or PETs for short.

There’s no limit to how much you can gift as a PET, however the value of the gift would only be exempt from IHT if you survive for seven years after it’s made.

If you pass away within this seven-year period, the gift becomes chargeable and would then increase the overall tax bill. Your executors can claim taper relief which reduces how much tax there is to pay on the excess you’ve gifted over your available nil rate band.

This relief is available between three and seven years after the gift is made. The longer the period between the transfer and your passing, the greater the taper relief and therefore the lower the tax.

Consider taking financial advice

Inheritance tax planning can be a complex area, so if you’re unsure or just want a helping hand, consider taking financial advice. HL’s financial advisers can advise you on how to use tax allowances, but in more complex circumstances they could recommend involving your accountant and solicitor to complement their advice.

Investing or saving

Putting money in a children’s savings account could be an option, but inflation – the change in the purchasing power of money over time – will likely eat away at the ‘real’ value of those savings.

Cash is usually a good idea for short-term savings, where the money is needed in less than five years.

Over longer time periods, investing in the stock market could help beat inflation. It also offers the potential for greater rewards in return for accepting a higher level of risk.

Remember though, unlike the security offered by cash, investments can go up and down in value, so a child could get back less than you put in.

Find an investment account

If you’re looking to invest for a child, we have three investment accounts for children.

All HL accounts can be linked, so you can view all your family’s accounts in one place. And you can view them online or with the HL app.