The 12 days of gifting

What’s the best way to pass on your wealth? When does a good deed become a burden? With Christmas being the season of giving, we’ve taken a look at some of the most important things to remember when it comes to financial gifts.

1. A cash gift

A cash gift can express gratitude, help someone in need, or support a worthy cause. And, with a well-managed gifting strategy you can reduce the size of your estate for inheritance tax (IHT) purposes – and the burden on your beneficiaries.

You’re free to gift as much as you want. But there are rules if you want to keep IHT to a minimum. Most important is the seven-year rule. If you die within seven years of giving a monetary gift, this could result in an IHT charge for the beneficiary. The standard rate on anything over the £325,000 threshold is charged at 40% Although the rate at which this applies to gifts starts to taper after 3 years after the initial gift is made

Remember: Make records of what you’ve given to whom, and when. Make sure everyone’s aware of the potential tax implications. It will save stress (and money) later.

2. Sticking to your annual exemption

The key to managing IHT when gifting is knowing what’s included and what’s not.

Everyone has an annual exemption which allows you to gift up to £3,000 each year free from IHT.. Routinely gifting up to that limit each year over time can seriously reduce the portion of your estate that’s liable for IHT after you die.

Remember: You can carry forward any unused part of your exemption into the next tax year, but you can’t roll it over any further than that. For example, if Daniel makes gifts of £1,000 to each of his two children in year one, he’s got £1,000 of ‘unused’ exemption for year two that can be added to that year’s allowance. For year three, that initial unused exemption would be lost.

3. Making smaller gifts

You can make small gifts – up to £250 – every year which won’t be hit by IHT. This is on top of your £3,000 annual exemption.

You can make these to anyone except those who’ve already received a sum included in your annual exemption. For example, if Susan gifts £3,250 to her daughter in a single year. The first £3,000 wouldn’t be subject to IHT (assuming she’s not made any other gifts). But the rest would be treated as a ‘potentially exempt transfer’ meaning there would be a tax charge if she doesn’t survive for seven years after making the gift.

Remember: It’s a strict limit of £250 per person, per financial year. Unlike your annual exemption, you can’t carry forward your small gift exemption into the next year.

4. Wedding or civil partnership gifts

Gifts in respect of marriage or civil partnership are an increasingly popular form of gifting. The good news, if you’re considering this, is that these are exempt from IHT too. You can make these gifts on top of your £3,000 annual exemption.

As an individual you can give up to £5,000 to a child – so you and your partner could give a total of £10,000. You can give £2,500 to a grandchild or great grandchild and £1,000 to any other relatives (or anyone else).

Remember: For the gift to be effective for IHT purposes, you must make it before the wedding has taken place.

5. Making regular gifts from your surplus income

There’s another way of gifting to your nearest and dearest without falling foul of IHT – you can take the gift out of your income.

Celebrating birthdays or Christmas, contributing to a child’s savings account, maintenance payments to an ex-partner, or any regular payments; these can all be exempt from tax if you can show you’re taking them from your surplus – and crucially, already taxed – income. The key here is regular. Whether it’s monthly, quarterly, or once a year, you’d need to demonstrate it’s not a one-off gift.

Remember: You should be able to maintain your current standard of living after making the gift. If you’ve dipped into your savings after making it, then it wouldn’t be classed as income.

6. Gifting into a trust

Want to make a gift, but not straight away? Or maybe you want more of a say in how it’s spent? One solution could be gifting into a trust.

There are two types: an ‘absolute trust’, typically applying to minors who inherit it once they’ve reached 18 (or 16 in Scotland); or a ‘discretionary gift trust’, where conditions may be attached. The trustees, as per the Settlors wishes, get to decide who benefits and when. Remember: Like any other long-term investment, the money in the trust will grow over time, meaning there’s the potential to increase the size of the gift  as the growth will be outside of your estate for IHT purposes. However, depending on your circumstances up front IHT may be charged on the creation of the trust so specialist advice should be sought to make sure this is right for you.

7. Gifting to your children with a Junior ISA

The interest on any parental gifts to their children in excess of £100 is taxed on the parents rather than their children. Therefore, If you want your gift to help your child save for their future, then a Junior ISA (JISA) is a popular and potentially effective method.

You pay in up to £9,000 every year, with the choice of either a cash-based or stocks and shares JISA. Once your child turns 18, the JISA is transferred to them. They can access their money from age 18, when the account becomes a traditional ISA. Making a JISA contribution can be a good way to maintain your tax efficiency, as this is on top of your annual £20,000 ISA allowance.

Alternatively, you can invest directly in their retirement, paying into a Junior SIPP. Each year you can pay in up to £2,880 (tax relief means this contribution would become £3,600).

Remember though that gifting to JISA’s or Junior SIPPs would be treated as a potentially exempt transfer, unless this was part of your annual exemption, a ‘small gift’ exemption, or a gift from surplus income.

 8. Gifts from grandparents

Many grandparents want their gifts to grandchildren (or great-grandchildren) to serve a purpose rather than just sit in a bank account. Using it to fund education, such as private school fees or university tuition, is a common route.

From January, private schools are no longer exempt from VAT, pushing up the cost of attending. So, the bank of Nana and Gramps could become even more popular in the future.

You can make direct payments to the school, or to the child, but it might be worth exploring using a trust. Income generated by the trust is taxed at the beneficiary’s rate of tax (and as this is a child or student it’s likely this would be a lower tax rate than other members).

This is preferential to parents placing funds into the trust for their children, as any income generated from these would be taxed at the parents’ marginal rate of income tax.

Remember: Money in the trust would be free of IHT as long as the donor survives seven years after making the gift.

9. Leaving a gift in your Will

For many of us, the biggest gifts we make are in the legacy we leave behind – our Will.

There are three main types:

• Specific: A property, artwork, items of jewellery or a family heirloom. Take care to make sure these are sufficiently described to avoid any misunderstandings in the future.
• Residuary: A percentage of your estate that’s left after taxes and costs.
• Pecuniary: A specific sum left to one person or a group of people.

Remember: gifts in your Will are distributed once costs and taxes have been taken off. It is advisable to review your Will and make sure this allows for your estate to be distributed as efficiently as possible and in line with your wishes.

10. Gifts to charity

Using the wealth you’ve grown over your lifetime to support a cause that’s close to your heart can be incredibly fulfilling.

You can make gifts to charities free of IHT during your lifetime which can also help to reduce your income tax liabilities.   However, many people choose to leave money in their Will. You can donate a fixed amount or specify a percentage of what’s left after other gifts are distributed.

Leaving money to charity can be an effective way of reducing IHT liabilities for your beneficiaries. If you leave more than 10% of your estate to charity, this automatically reduces the tax rate down from 40% to 36%.

11. Gifting with reservation of benefit

Be warned. This is one area of gifting where you have to be very careful.

A ‘gift with reservation of benefit’ means the donor still retains some sort of use or control over the asset they’ve gifted. It’s not considered a full transfer of ownership, so therefore is still liable for an IHT charge.

Take this example: Graham gifts his £650,000 home to his children early, rather than leave it to them in his Will. Doing it this way, he hopes to benefit from the seven-year rule exemption (a potentially exempt transfer). But he continues to live there. As a result, the seven-year rule doesn’t apply. When he dies, his children pay IHT on the property.

There are two ways that may help avoid this:

• Pay rent – at full market value.
• The donor is ‘virtually excluded’ from benefiting. For example, if it’s a property, the donor and beneficiary now stay in the same home.

12. Gifting your pension

Since pension freedom reforms in 2015. You’ve been able to ‘gift’ your unspent pension pots to the next generation. It’s become an increasingly effective tool for estate planning as retirees have drawn down from other investments instead – minimising IHT liabilities.

This will change from April 2027. Pensions are losing their exemption, meaning for more people the value of their estates will exceed the £325,000 threshold. This will mean a change in approach for some to their retirement. It could mean greater levels of gifting as retirees draw down larger quantities to avoid their estates being overburdened.

Gifting is a complicated process – particularly in areas like setting up a trust.

Please get in touch with our experts who can help talk you through any of these decisions.