Inheritance Tax (IHT) is usually paid by the estate of someone who has died and is passing on their assets, so long as the total estate is valued over £325,000. To try and reduce the costs involved, many may turn to gifting but changing habits on this may lead to more people facing costly bills.
Gifting practices change
The Government will allow people to gift away assets free of tax up to certain limits, and many people will give money away to lower their estate’s value and (hopefully) avoid IHT. However, while many people usually give away assets when they die, often through a Will, more families are choosing to do so while they’re alive, raising the chances of being hit by IHT.
Recent research from Canada Life showed over a third of parents (38 percent) have already passed on significant financial gifts to the next generation. Of those who had gifted the top reason for doing so was to support children or grandchildren with general living expenses (21 percent).
Almost two-fifths (18 percent) said it wasn’t for a specific purpose and they just wanted to reduce the value of their estate. While 17 percent did so to fund the purchase of a car and 15 percent to fund other major purchases.
Speaking to those who had gifted to their children, 37 percent said they could afford to spare the money, so it has had little or no impact on them. However, 17 percent said that since giving the money they have found themselves short of funds in an emergency and 15 percent have had to cut back financially since giving the money.
Andrew Tully, a technical director at Canada Life, commented on the research.
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He said: “The desire to pass on wealth to the next generation isn’t new but traditionally that has been done following death. Increasingly, many parents or grandparents want to see their children benefit from the money at a younger age rather than wait for an inheritance. However it is concerning for the financial future of the next generation that the most common use for these gifts is to support day-to-day living costs rather than fund significant one-off purchases.
“It is important that anyone wanting to bestow a financial gift to the next generation first seeks financial advice. An adviser will help identify how much you can safely give without jeopardising the health or enjoyment of your own retirement, and make sure it is done in an effective and tax-efficient manner.
“The research shows that more than one in 10 parents who make a gift feel it may negatively impact their own retirement planning. The right advice will help make sure people are fully aware of the consequences before taking any action.”
While pensions and retirement planning may be hit by gifting early, many may not be aware it also poses repercussions for estate planning.
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IHT rules on giving gifts
Currently, IHT may have to be paid on gifts given while a person is alive. IHT may be levied if a gift, which includes money and personal goods, is given less than seven years before the giver died.
No tax will be due on gifts given if the person lives for seven years after giving them, unless the gift is part of a trust. This is known as the “seven year rule”.
If a person dies within seven years of giving a gift and there’s IHT to pay, the amount of tax due depends on when the person gave it. IHT will be levied on a sliding scale known as “taper relief”.
The taper relief rates are as follows:
- Years between gift and death – three to four years, rate of IHT on the gift – 32 percent
- Four to five years – 24 percent
- Five to six years – 16 percent
- Six to seven years – eight percent
- Seven or more – zero percent
These timeframes are important to note as while IHT due on gifts is usually paid by the estate, once a person has given away more than £325,000, recipients who get a gift from them in those seven years will have to pay the IHT.
While many families may assume they will not have to worry about IHT at all, the latest data from HMRC shows the Government is collecting record amounts of the tax.
In mid-November, tax statistics released by HMRC showed Britons paid £392billion in tax between April and October this year, up £99.8billion from the same period a year earlier.
Of this, IHT made up £3.6billion, £600million more than the same period in 2020 and a rise of 20 percent.
Shaun Moore, tax and financial planning expert at Quilter, responded to these statistics. While he noted gifting can indeed help with IHT planning, caution should be exercised.
He said: “One factor likely contributing to the increase in IHT receipts is the soaring housing market. Despite the stamp duty holiday drawing to a close at the end of September, the race for space continues and this week’s ONS data showed a record high average UK house price of £270,000. With inheritance tax thresholds frozen, which is viewed as a stealth tax rise, more people will be facing IHT bills following the sales of their homes.
“This tax year, you can pass on £175,000 of your property tax-free, which is effectively doubled to £350,000 when combined with the allowance of your spouse or civil partner. That’s layered on top of your inheritance tax allowance – or nil rate band – of £325,000, meaning it is possible to pass on £1million inheritance free as a couple.
“However, the RNRB only works for those with direct descendants to inherit the family home, while the UK’s six million cohabitees are less fortunate and cannot claim the combined allowances.
“There are other ways to reduce your inheritance tax exposure, such as gifting to family members. Each tax year you can give away up to £3,000 worth of gifts with your annual exemption, so as a couple you could gift £6,000 a year. In addition, there is no limit on excess income – above expenditure – that can be gifted.
“Unfortunately, gifting allowances have failed to keep up with inflation, and the currently soaring inflation rates will do little to help matters in terms of IHT bills. If required, you could also consider more significant gifts which would be Potentially Exempt Transfers (PETs) or Chargeable Lifetime Transfers (CLTs), but these will take seven years to see the IHT benefit. As well as reducing the taxable estate value, gifting is particularly useful for estates impacted by the RNRB taper as the gifts can immediately reclaim the extra band.”