Staying alive is the name of the game when it comes to gifting money - Gareth Shaw

Q I’m 83 this year and plan on staying around for many years to come. I have amassed £100,000 in savings, for which I have no real need, and I want to distribute this among my three grandchildren. I know I’ll need to survive for seven years after giving the money away but are there any other rules I need to be aware of so that they don’t end up paying tax?

Everyone has an annual gift allowance of £3,000 per tax year.

A Inheritance tax is much feared (and often loathed), but the reality is that very few estates pay it. Data from HM Revenue and Customs (HMRC) shows that while it earned £5.2bn in inheritance tax in the 2019-20 tax year, just 3.8 per cent of all deaths resulted in a bill.

That said, it’s right that you’re taking this into consideration when planning to distribute your estate. We’ll start with the inheritance tax basics as it’s important to understand the fundamentals as you plan.

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Inheritance tax is charged at 40 per cent of your estate. This rate can be reduced to 36 per cent if you donate ten per cent of your estate to charity. It is charged on the excess of your ‘nil-rate band’ – an inheritance tax-free allowance. This is made up of two parts, but not everyone is eligible for both. The main nil-rate band is £325,000, available to everyone. The second part is only available to people who have included a property in their estate, which is being inherited by a ‘direct descendant’ – a child or grandchild. In the current tax year, this is £175,000, meaning the total you could give away tax-free is £500,000. Anything above that amount is subject to inheritance tax.

If you’re married or in a civil partnership, your partner can inherit your entire estate tax-free, along with your tax-free allowances. Combined with theirs, this could enable a couple to give away £1m tax-free. However, the benefits begin reducing if your estate is worth over £2m – the £175,000 property allowance is reduced by £1 for every £2 that your estate exceeds £2m.

So, onto gifting. This can be an effective way to reduce a potential inheritance tax bill and reduce complexity for your heirs. Everyone has an annual gift allowance of £3,000 per tax year, and if you don’t use your allowance, you can carry it over once, allowing you to give away £6,000 in one year. You also have a small gift allowance, which allows you to give away unlimited gifts of up to £250 to a person without them being subject to inheritance tax, although they can’t go to anyone that’s benefitted from your annual gift allowance. You can also give up to £5,000 to children and £2,500 for grandchildren for weddings (as well as £1,000 for anyone else).

If the money you’re giving falls out of these – and in your case, it does – you’re making something known as a potential exempt transfer. As you rightly point out, if you die within seven years of making one of these gifts, it will be added to your estate and inheritance tax could be payable if your estate exceeds your tax-free allowances.

The amount of tax payable reduces the longer you survive into that seven-year period. If you die within three years of making a transfer, a 40 per cent rate will apply, which reduces to 32 per cent if you die within four years, then to 24 per cent, 16 per cent and eight per cent each year, respectively, thereafter. This is called taper relief.

However, most gifts don’t become taxable because the £325,000 allowance is allocated to gifts made within seven years of the giver’s death before the rest of the estate. That means the bill will fall to those inheriting the bulk of your estate when you die, rather than those who received gifts while you are alive.

I would suggest discussing this with your family and keeping a record of your gifts – not only will everyone be clear about where and why your money has gone, it will make administering your estate easier. Hopefully not for many years to come!

Gareth Shaw is the Head of Money at which.co.uk

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