Inheritance tax and gifting: a guide for grandparents

The introduction of inheritance tax on unused pensions from April 2027 is changing the landscape when it comes to estate planning.

I’ve had many clients asking me how best to preserve what they leave for their children and grandchildren as a result of the change.

A key tool in your defence against inheritance tax charges is gifting.

Used carefully, gifting money to family can help provide a wide range of benefits both during your lifetime and for many years afterwards.

Here we break down some of the main ways you can make gifting work for you.

One-off gifts

You can make one-off gifts of up to £3,000 in any tax year to any individual without attracting any tax charges.

You can also carry forward unused allowance from the previous year. So you could gift up to £6,000 in a tax year if you haven’t used the allowance in the previous year.

There are also special exemptions for weddings and civil partnerships.

You can gift an additional amount:

• up to £5,000 to a child
• up to £2,500 to a grandchild or great-grandchild; and
• up to £1,000 for anyone else without it counting towards inheritance tax.

You can gift up to £250 per person per tax year if that person hasn’t received part of your £3,000 annual exemption.

But while one-off gifts are useful – particularly for special occasions – they are unlikely to have a lasting impact.

So what else can you do to help your family whilst cutting down on potential inheritance tax bills?

Larger gifts

It is possible to make larger gifts in addition to those mentioned above without running up an inheritance tax bill.

However, these must be made during your lifetime. You will also need to survive for seven years after making the gift to avoid paying inheritance tax completely.

These gifts are known as Potentially Exempt Transfers – or PETs for short.

Gifts made during the last seven years will use your nil rate band. It is important that you understand this and discuss with your adviser how to manage this.

For example, if you made a gift of £200,000 and died within seven years then you would lose £200,000 of your nil rate. IHT would then be due on any assets over £125,000 (not taking into account the residential nil rate band).

For larger gifts made over the nil rate band, inheritance tax is charged (on the amount over the nil rate band) on a sliding scale as follows:

As an example of how this works, let’s look at a large gift of £400,000.

If you live for seven years or more after the gift has been given, your family will not have to pay inheritance tax on it.

If you die less than seven years after it has been given, your family will have to pay inheritance tax on £75,000 of that gift (the amount over the £325,000 nil rate band) at the rates above.

It is possible to protect the loss of these nil rate band allowances during a 7-year period via life assurance policies.

Regular gifts from income

One of the most effective ways of reducing inheritance tax bills and making a big difference to your family is by regular giftings from income.

In this context, ‘income’ can be money earned from your job or money paid from a pension.

The important part from a taxation point of view is that these regular gifts do not affect your standard of living and that you intend to make the gift on a regular basis.

HMRC define ‘regular’ as at least annually. You also need to make the gifts of a similar value in order to avoid inheritance tax on them.

For example, if you decide to gift your child £500 a month or £6,000 a year from your pension, this would be acceptable.

However, if you gifted £10,000 in one year, £500 the next year and then £8,000 the following year, this would not be regarded as regular gifting.

The gifts must also be at a level that you do not have to draw on your capital e.g. savings to supplement your standard of living.

Gifting into an ISA

A good way to maximise the regular gifting allowance is to pay the gifts into an Individual Savings Account (ISA).

Assuming this is done on a regular basis with similar amounts, this would qualify under the regular gifting rules.

And while you may have paid income tax on either your income or salary, your child or grandchild will not pay tax on gains made from their ISA. This applies whether that is a cash ISA or a stocks and shares ISA.

The range of ISAs available – including junior ISAs for under-18s and Lifetime ISAs for over-18s looking to get on the property ladder – means you are likely to find one which fits your family’s needs.

Gifting into a pension

A common concern about regular gifting into an ISA or other account is that the money may be frittered away.

Not every young adult is careless with cash, but the temptation to spend may be too great for some to resist.

With that in mind, another way to use regular gifting money to family is to pay into a pension.

While it may seem too soon to start a pension, particularly for your grandchildren, the opposite is actually true.

If the pension is invested wisely, the earlier you start it, the more it will be worth by the time you can use it.

Also, under current legislation, your child or grandchild won’t have access to the pension fund until they’re at least 58. This ensures that you shouldn’t be too concerned about them drawing it out to spend.

You should not give away too much of your income such that you have to draw on your capital to supplement your standard of living.

Recording your gifts

Whatever way you decide to make gifts, keeping records of what you do is vital.

Not only does a correct record show compliance with HMRC rules, but it will also save your executors a lot of time and stress on paperwork after you have gone.

The way I recommend clients keep a record of this is via a form available from HMRC – the IHT 403 form.

Part of this form can be used to demonstrate the pattern of gifting and also proves to HMRC that these were from surplus income rather than capital.

I’ve worked with many clients on this aspect of gifting money to families and on a range of strategies to maximise what they pass on to their loved ones.

Key takeaways

Gifting money to family is a great way to make a real difference to their lives while reducing the potential burden of inheritance tax.

For a gifting strategy which works well for you, get in touch with us today.

Disclaimer: This article is for informational purposes only and does not constitute financial, tax, or legal advice. Tax treatment depends on individual circumstances and may change. Always seek professional advice before making financial decisions. It is important to note that the value of investments and the income from them can go down as well as up and that you may get back less than the amount you invested.