Gifting money to the next generation: When is the right time to help our children financially? 

 You should meet your income needs first   

Making an outright gift of money relinquishes any future control or personal use of that money, so it is essential to ensure that it is financially affordable.  

 Before making any lifetime gifts, you should carefully consider your own lifetime income needs. Cashflow planning is critical, including potential capital needs and the provision of long-term care in the future.    

A useful starting point is to calculate your annual expenditures, factor in lifetime events such as weddings or car purchases and include a contingency fund to ensure headroom for unforeseen needs.   

Understand your allowances   

Gifting raises the concern about being caught out by Inheritance Tax (IHT). As a result, people often ask advisers about the rules and tax implications of gifting to a family member.   

There are several gifts permitted each year which are exempt from Inheritance tax rules: 

• The annual exception: An individual has an annual gift allowance of £3,000 per annum, which can also be backdated one previous tax year. This rule allows a couple to pass on up to £12,000 in the first year and £6,000 each subsequent year.  
• Additional gifting allowances: for weddings, education fees and an unlimited small gifts allowance of £250 per annum are also permitted, without a potential IHT liability (limitations apply).     

The seven-year rule   

Any gifts above the annual allowances are known as ‘potentially exempt’ (PET) and will be subject to IHT on a sliding scale over the following seven years.     

No tax is due on any lifetime transfers if the donor survives seven years after making the gift – this is known as the seven-year rule.   

If the donor dies within seven years, the gift becomes chargeable. Its value will either reduce or eliminate the deceased’s nil rate band (the amount that can pass to beneficiaries without creating an IHT liability). The rate at which IHT is due gradually reduces over the seven-year period.   

House prices continue to rise, and the most attractive mortgage deals require larger deposits, so it is now commonplace for large gifts to help younger family members buy their first home.    

Gifts Made Out Of Income   

Surprisingly, people often overlook the ability to make gifts out of income, which is one of the most valuable exemptions from IHT. 

The exemption is limited only to the extent of the donor’s (net) surplus income. Gifts out of income are immediately exempt from IHT provided the following conditions meet: 

1. The gift must be a part of the donor’s normal expenditure – HMRC expects to see a regular pattern of payments.  

2. The donor must retain sufficient income to maintain his/her standard of living 

3. Gifts must be made out of income; in other words, they cannot come from invested capital 

Regular gifts could include Christmas and Birthday presents, funding the annual family holiday, insurance policy premiums, education costs or private healthcare arrangements. 

 Skipping A Generation   

The baby boomer generation is often described as the ‘caretakers’ of wealth; inheriting money that their own children will eventually inherit.  

This could cause a ‘double whammy’ effect as far as Inheritance Tax is concerned. Therefore, families need to have open conversations about their Wills and beneficiaries, as some individuals may choose to pass inheritances directly to their grandchildren, skipping a generation.    

This may also be done following death through a deed of variation. A deed of variation allows beneficiaries to change their entitlement from a Will after the person has died.  

Beneficiaries can only amend their share of any inheritance and the Executor, and all other beneficiaries of the will must agree if they are affected by the changes.  

Beneficiaries should make any changes within two years of death, so the deed of variation is treated as if the deceased had written them into the original Will. 

Junior ISA vs Pension  

Both Junior ISAs and Pensions are popular destinations for gifts; it is useful to understand the difference.      

Junior SIPP  

The SIPP will attract 20% tax relief on contributions. However, as children are generally non-earners, these contributions will be limited to £3,600 p.a gross, a net payment of £2,880.    

Over an 18-year period and growing at 5% net of fees, the pension is likely worth c.£101k, left invested with no further contributions until they are 65, the fund will have reached £1m.     

Remember that your children can only access the funds at the minimum pension age, which is currently 55 and rising.   

 Junior ISA

 Whilst the ISA does not attract tax relief on the contributions, the funds become available to the child at 18.   

 Investing the full £3000 gift allowance into a Junior ISA each year from birth with a 5% net of fees growth rate would see a fund value of c.£84,400 on the child’s 18th birthday.   

Be Transparent   

You must keep financial records of your gifts, including their value and the date. If HM Revenue & Customs checks the data, having this information should speed up the process.    

This will also aid the Executor of the estate in administering the estate on death. 

 If you want to learn more about IHT, you can also read a previous article where we cover some more complex areas. 

Your Wealth Manager can help you make these important financial decisions; complete cash flow analysis and income sustainability stress tests, help calculate a potential IHT bill, and advise on whether your gifts could create tax charges for the recipients. 

If you have any questions, contact your Wealth Manager here.