Inheritance Tax Planning: Tax Efficient Gifting to Grandchildren

As a grandparent, you may be considering giving money to your grandchildren as a way of helping them financially or simply passing on some of your wealth to future generations. However, it is important to understand the tax implications of gifting in the UK as Inheritance Tax can be due on gifts if the donor does not survive for 7 years from the date of the gift.

Getting professional advice about how you can give away some of your wealth tax efficiently during your lifetime should be given due consideration. This is because how you gift your wealth can affect how much your grandchildren actually receive.

For the purposes of Inheritance Tax, a grandchild or a great grandchild is a remoter lineal descendant. It is also interesting to note that the definition of “child” for these purposes includes stepchildren, step-grandchildren and children of fostered children.

Examples of tax efficient ways to gift to grandchildren

Use your annual gift allowance

One of the simplest ways to gift money to your grandchildren is to use your annual gift allowance. In the UK, each donor can give away up to £3,000 each tax year without it being subject to inheritance tax. The £3,000 can be given to one grandchild or split between multiple recipients.

If you don’t use your full allowance in one tax year, you can carry any unused annual exemption forward to the next tax year – but only for one tax year.

With each living grandparent able to gift an annual total of £3,000, gifts totalling £12,000 could be made if the previous year’s allowance has not been used at all.

Give small gifts

In addition to your annual gift allowance, you can also give small gifts of up to £250 per person per tax year without it being subject to IHT. This can be a great way to give your grandchildren small, regular gifts without having to worry about the tax implications. Great care should be taken about the interaction between the annual exemption and the small gifts exemption. The two cannot be used in conjunction with each other. In other words, you cannot give a grandchild a total of £3,250 and claim that the first £3,000 is subject to the annual exemption and the small gifts exemption applies to the remaining £250.

For the small gifts exemption to apply the gift must be an absolute small gift of £250 or less.

Set up a trust

Setting up a trust can be a more complex way of gifting money to grandchildren, but it can offer significant tax benefits. By placing assets into a trust, you can potentially reduce the amount of IHT that will be due on your estate. You can also set conditions on the distribution of the assets, ensuring that they are used for specific purposes, such as education or property purchase.

There are several types of trusts that can be set up, such as Bare Trusts, Life Interest Trusts and Discretionary Trusts. It’s essential to seek advice from qualified professionals, as they can help you assess your specific situation and determine which type of trust aligns with your goals and objectives. With the right advice, trusts will prove to be an extremely flexible and effective means of passing wealth onto future generations. They have the potential to be, not only, inheritance tax and capital gains tax efficient but also income tax efficient for the beneficiaries as well.

Set up a Junior ISA

A Junior ISA is a tax-free savings account that can be opened for children under the age of 18. You can contribute up to £9,000 per tax year into a Junior ISA, and any growth or income earned within the account is tax-free. When the child reaches 18, the account will convert to a regular adult ISA.

It is worthwhile noting that the £9,000 allowance is per Junior ISA account and not the amount given by each person. As an example, if a parent puts in £3,000, the maximum contribution the grandparents could make would be £6,000. Grandparents could use their £3,000 annual exemption for this purpose.

Pay for education or medical expenses

If you are looking to gift money to your grandchildren for specific purposes, such as education or medical expenses, you may be able to do so without incurring any tax. In the UK, there is no limit on how much you can gift for these purposes, as long as the payments are made directly to the educational or medical institution.

Gifts for weddings or civil partnerships

You are able to gift £2,500 to each grandchild or great-grandchild on top of any other allowance (excluding the small gift allowance) in the same tax year. As an example, you could provide £3,000 under the annual gift allowance, along with a wedding gift of £2,500, totalling £5,500.

Gifting from surplus income

Commonly known as “gifts out of normal expenditure”, gifts from a grandparent’s surplus income can be given to grandchildren without incurring any inheritance tax liability.

To be exempt from Inheritance Tax liability, the gifts must meet several conditions:

• they must be made as part of the donor’s normal expenditure. This means that the gifts must be made regularly and the donor needs to establish a pattern of gifts. They must leave the grandparent with enough income to pay any income and liabilities and also to maintain their usual standard of living.
• They must be made from the grandparent’s income, rather than capital. This means that the gifts must be made from income that is surplus to the grandparent’s needs.

The definition of income plays a critical role in determining how this regulation applies. As the rule’s title implies, gifts must originate from income and cannot come from capital sources such as liquidating investments. Earned income received through employment, rental income, income from a pension, and dividends earned from investments are all eligible sources of income.

It is important to note that the burden of proof is on the executor of the donor’s estate to prove that the gifts meet these conditions, so it is important to keep good records of the gifts made.

In conclusion

Tax-efficient methods of gifting money to grandchildren abound, by creating a careful plan of lifetime gifts which take full advantage of available exemptions and Trust vehicles, considerable inheritance tax savings can be made. Obtaining expert advice is essential in order to avoid possible inheritance tax bear traps and pitfalls.

It is always important to seek specialist advice before making any significant financial decisions. For detailed advice and guidance on reducing Inheritance Tax liabilities, please contact David Gillies at Friend Partnership. You can call David on 0121 633 2007 or contact him by email at david.gillies@friendllp.com