Making gifts and Inheritance Tax: a guide for grandparents
Put simply, the best way to reduce your inheritance tax liability is to give away as many assets as you can as early as possible. If you survive for 7 years after you have made a gift then this will not form part of the overall picture for inheritance tax. However, it is important that you are careful not to trigger a charge to capital gains tax. Therefore it is always best to make cash gifts rather than gifting physical assets, such as property.
Do not forget that each person has an annual exemption to make a gift of £3,000 free of inheritance tax (any unused annual exemption can be carried forward one tax year). Over a few years this can add up to a substantial sum and can be useful if you plan to help grandchildren to get on to the property ladder.
Further tax reliefs
Each individual domiciled in the UK can leave assets equivalent to the value of the nil rate band (currently £325,000) free of inheritance tax but, thereafter, his or her assets are taxed at the flat rate of 40%.
The Government are also introducing a new residence nil rate band, meaning that after 6th April 2020 a married couple will be able to leave £1m worth of assets free of inheritance tax (although this relief has complex rules applicable and therefore it is important to seek legal advice when making a Will).
You could also be eligible for inheritance tax relief when making gifts out of income provided that you maintain your previous standard of living from the balance of your income.
Grandparents can also make cash gifts to grandchildren of up to £2,500 if they are getting married or entering a civil partnership.
There are many other tax reliefs available which cannot be covered by this blog and if you are considering making a gift then professional advice should be sought.
Sometimes, setting up a trust can be the most tax efficient way to gift money to grandchildren. For example, a trust could be set up to pay school or university fees into which a grandparent could make a one off capital gift or make use of the regular gift out of unused income exemption.
Of course, disposing of assets early is not always an option for everyone. A flexible Will can mean that your executors, who are commonly adult children, can decide how to distribute assets (i.e. whether they need them or whether they should skip a generation). The advantage of this approach is that those assets never form part of the “middle” generation's and are thus not taxable to inheritance tax on the death of that generation.
You can still change a Will after someone has died
Within two years of a death, adult children who have inherited could alter a Will to leave their share directly to their children by a deed of variation thus, effectively, “skipping” a generation. It is important to take legal advice at this stage.
The most important thing you can do is to make a Will and think about tax planning. Your family will thank you for being prepared, but the taxman may not!