If you want to help your children or grandchildren by giving them money for a deposit or university fees, what are the rules?
Many people worry about having to pay inheritance tax when they die, but few are aware that they can give money away while they’re still alive. The rules are quite strict so you can’t give away a fortune, but you may be able to give away more than you think. What you shouldn’t do is try and give away so much money that you don’t have enough left to live on because the chances are you’ll also fall foul of HM Revenue and Customs’ rules.
How much can you give away?
HM Revenue and Customs lets you give away some money every year without risking an inheritance tax bill when you die. The rules say you can give away:
• Up to £3,000 in any one tax year. You can give the £3,000 away to one person or to several. If you don’t give away the £3,000 in total one year you can use up the remainder of your allowance in the next tax year. However, you can’t ‘carry over’ the unused portion beyond one year.
• Up to £250 to anyone you like. You can give away as many gifts of up to £250 as you want to but you can’t give more than £250 to that person. If you do, the inheritance tax free exemption is lost.
• Money when a family member or friend gets married. If your son or daughter gets married each parent can give cash or gifts worth up to £5,000, grandparents can each give up to £2,500 and anyone else can give up to £1,000.
SAVVY TIP: You have to either hand over the money or promise to do so before the date of the wedding/civil partnership ceremony or on the day itself. If the wedding/civil partnership is called off or you give the money after the ceremony and you’ve not promised it first, the inheritance tax exemption doesn’t apply.
• Gifts out of income from normal expenditure. This is an inheritance tax allowance that many people don’t know about and it can be a trickier one to assess. The rules say that if you can afford to make regular gifts out of the income you receive (it can’t be out of your savings or other capital), you can give these away without having to pay inheritance tax The gifts have to be regular, but don’t have to be monthly. For example, you could give a regular allowance to a child or grandchild, give regular Christmas and birthday gifts or pay into a stakeholder pension on their behalf. There's more information on giving away money in your lifetime on the HMRC website.
SAVVY TIP: Karen Ritchie, an independent financial adviser with FPW, says that it’s important to have a good ‘audit trail’ for HM Revenue and Customs. “I recommend that clients write a letter to the person benefiting from the gift, saying that they are making a payment out of their income. They should keep a copy with their will so that the executors know exactly what’s been given away.”
Giving away money and surviving for seven years
There is another way that you can give money away while you’re alive and not face the prospect of an inheritance tax bill on the money you've given away, and that’s by using ‘potentially exempt transfers’ or the seven year rule.
It works like this:
• You give away money to your child/grandchild or whoever you like. It doesn’t matter how much you give them.
• You live for at least seven years after you’ve given away the money/assets.
• There’s no inheritance tax bill to pay on the money you've given away when you die. Your executors will need evidence of what you gave away and when you did it, but as long as you can show that you gave away the money/painting etc at least seven years before you die, they won’t have to pay inheritance tax.
• Gifts to charities or political parties You can give away money while you're alive (or leave it in your will) and there's no inheritance tax to pay on these gifts.
Surviving for less than seven years
The tricky bit is that none of us knows how long we will live for but it might still be worth giving money away because if you don’t survive for the full seven years your estate won’t have to pay inheritance tax on the full amount that you've given away.
• If you live for between three and four years after you’ve given away the money: there will be a reduction of 20% on the inheritance tax bill on the amount you've given away.
• If you live for between four and five years after you’ve given away the money: there will be a reduction of 40% on the inheritance tax bill on the amount you've given away.
• If you live for between five and six years after you’ve given away the money: there will be a reduction of 60% on the inheritance tax bill on the amount you've given away.
• If you live for between six and seven years after you’ve given away the money: there will be a reduction of 80% on the inheritance tax bill on the amount you've given away.
Using life insurance to pay inheritance tax
You can take out a life insurance policy to pay your inheritance tax bill, either a simple ‘term assurance’ policy that lasts for a set number of years, which will pay your inheritance tax bill if you don’t survive for seven years after you’ve given away some money, or a ‘whole of life’ policy, which guarantees to pay out when you die – no matter when that is.
SAVVY TIP: It's normally a good idea to write a life insurance policy 'in trust' so that the payout doesn't form part of your estate (which means there will be no inheritance tax (IHT) due on the proceeds of the life insurance policy). It's especially important to do so if you're taking out life insurance for the sole reason of paying an IHT bill.
There are pros and cons to each:
• A term policy is a cheaper option: that's because it will only pay out if you die within a certain term (in this case, seven years).
SAVVY TIP: Although the premiums will be relatively low if you’re in good health, you’ll still have the hassle of getting a medical and having all sorts of tests. If you’ve had major health problems you could find the policy costs a lot more or that death relating to this condition is excluded.
• A whole of life policy can cost hundreds of pounds a month: the flip side is that it’s guaranteed to pay out, no matter when you die.
SAVVY TIP: Louise Oliver of independent financial advisers Taylor Oliver says that, even with high premiums, whole of life insurance can be a good deal. “If you - as the person giving away the money - can't afford the premiums it may be that your children or whoever is benefiting from money you're giving them could pay."
Understanding your inheritance tax allowance or nil rate band
Married couples and civil partners can transfer their inheritance tax allowance
When can a will be contested?
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