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What to consider before agreeing to give early inheritance

James Daley - Fairer Finance founder and Managing Director.

James Daley

Money expert and Founder of Fairer Finance

Last updated 21st January 2021

7 min read

If you’re in retirement and making plans for how to distribute what you own when you die, it’s tempting to consider giving away your property and wealth today. In doing so, you get to see your family and friends enjoy the gifts you are giving them – and you can potentially save the taxman taking a share of what you give.

However, it’s important you understand the tax rules before you start to give your assets away. Just because you’re still living, it doesn’t mean you can avoid inheritance tax entirely. And you may also inadvertently incur other tax liabilities like Capital Gains Tax.

This guide tells you what you need to know if you’re thinking of giving some of your inheritance away early.

How inheritance tax works

Only around 5% of people who die pay any inheritance tax – so most people don’t need to worry about planning for it.

You don’t have to pay anything if you have assets of £325,000 or less when you die. This is called the Nil Rate Band. And if you’re married or in a civil partnership, you can give everything you own to your surviving spouse when you die without having to pay any inheritance tax. They will also get the benefit of your inheritance tax allowance, meaning they won’t need to worry about paying any inheritance tax unless you have combined assets of over £650,000.

If you are passing your family home onto your children or grandchildren, you can also get extra relief of £175,000 on top of your regular inheritance tax allowance – or £350,000 if you’re a couple. This is called the Residential Nil Rate Band.

That means that for most couples, there’s no inheritance tax to pay unless you have combined assets of more than £1m. While that’s a lot of money, rising property prices are putting more and more people over the top of that threshold. And If you think you could end up having to pay inheritance tax, it’s worth doing some planning.

If your estate is worth more than £2m, you will lose some of the Residential Nil Rate Band. The amount reduces, the larger your estate is above £2m.

Giving away your inheritance early

There’s nothing to stop you giving away money and things that you own while you’re still alive. You can give gifts of up to £250 a year to as many people as you like without having to worry about the inheritance tax implications. For gifts above £250, you have an allowance of up to £3,000 per year which you can use without having to worry about inheritance tax. This is called your gift allowance.

However, if you give gifts of more than £3,000 in a year and then die within seven years of the donation, some of the value of it will still be included when calculating how much inheritance tax is due on your estate.

When you first make a gift, it’s called a Potentially Exempt Transfer. But if you live for less than seven years after you’ve given the gift, it becomes known as a chargeable asset. How soon you die after giving the gift will impact how much tax is due. For example, if you die six years after giving the gift, you’ll only pay 8% tax on the amount.

However, if you die within three years of the donation, the full 40% will be due. The lower amounts for gifts given more than three before death is called taper relief.

Here’s the full details of the taper relief rates:

How long before the person died was the gift given? Tax rate:
Less than three years 40%
Three to four years 32%
Four to five years 24%
Five to six years 16%
Six to seven years 8%
More than seven years 0%

Exceptions to the rules

As well as everyone’s annual gift allowance, there are also some other exceptions which allow you to give gifts later in life without incurring an inheritance tax liability.

Weddings

You can give wedding gifts to your children worth up to £5,000 or to your grandchildren or great-grandchildren with a value of up to £2,500. If they’re not a close family member, you can still give a wedding gift worth up to £1,000. And none of these will impact your inheritance tax bill.

Birthday and Christmas presents

You can give normal gifts at Christmas and Birthday, which are covered by your income. But you must be able to maintain your standard of living after you’ve made the gift.

Surplus income

If you have more income than you need to live on – from your pension, for example – you may be able to make a contribution to family members each month. For example, by paying into your grandchildren’s savings account, or by paying into a life insurance policy for your children. You should keep a clear record of these gifts as the rules are complex, and it would be easy for these gifts to be counted as chargeable after you die if you have not made clear notes and records of what you were doing.

Help with living costs

You may be able to donate to children under 18 in full time education or to an partner or dependent.

Charitable donations

Donations that you make to charities will never count towards your inheritance tax calculation, and any charity donations you make in your will to be paid after you die will also be exempt.

Political parties

Gifts to political parties are also not included in your inheritance tax calculations.

Giving away a property before you die

The seven year rule still applies if you give a property away before you die. However, if you live seven years after giving the property away, you can avoid paying inheritance tax on it.

If you give it away and move out, then you simply need to live for another seven years, to avoid any tax being due. But if you give it away but stay living in it, then you’ll need to pay rent each month at the local market rate, and also pay your share of the bills and live seven years, to qualify for the inheritance tax exemption.

Giving away non-cash gifts

If you’re giving away things other than cash – such as stocks and shares or valuable artwork – you also need to give a thought as to whether you could end up creating a capital gains liability for you or the beneficiary.

It will depend what the gift cost you when you bought it or were given it, and what its value is now.

And of course, non-cash gifts are still subject to inheritance tax if you die within seven years of making the gift. So it’s all the more important to ensure you don’t end up getting taxed twice.

When’s the ideal time to give gifts away

Although most people don’t start thinking about inheritance tax until the end of their lives, it actually makes most sense to think about transferring some of your wealth when you’re younger.

If you’ve paid off your mortgage and debts, and have a steady income in retirement, it may be worth starting to give money away while you still have many more years to live. This has the double advantage of allowing you to see your family and friends enjoy the gifts you have given, as well as greatly reducing the chance that there will be any inheritance tax liability on what is left.

Many grandparents gift their grandchildren money to get through university – or give their children a deposit to buy a house.

As long as you live for at least seven years after the gift has been given, there will be no inheritance tax to pay.

Where to turn for help and advice

If you’ve got complex financial affairs, it’s well worth taking advice from a specialist inheritance tax adviser. You can use website such as unbiased.co.uk to find a specialist inheritance tax adviser in your area.

Or look for a financial adviser with chartered status at https://www.thepfs.org/yourmoney/find-an-adviser/.

You can also look for a chartered account by searching on the website of the Institute of Chartered Accountants in England and Wales.

Making a will

It’s also important that you draw up a will to make sure that your assets are distributed according to your wishes when you die. If you have fairly simple affairs, there are lots of cheap online will writers. You can find one by looking on The Times’ website.

Alternatively, if you have more complex affairs, you may need a full face to face consultation. You can find professional will writers in your area by searching on the website of the Association of Professional Will Writers.

If you don’t set up a will before you die, your assets will be distributed according to the law. This generally means they will go to your spouse, or your children and grandchildren. Dying without a will is called dying intestate. It tends to make the process of tying up your affairs a little more lengthy and time-consuming for your family.

Having it all squared away in a clear will can help take some of the burden off your relatives when you die.