It’s not uncommon to want to give a financial gift to your children or grandchildren before you pass away, so that you have the chance to see them make the most of the money – this is sometimes known as an early or ‘living’ inheritance.
An early inheritance can be made for many reasons, for example to help children or grandchildren cover university costs, or fund a big purchase such as a wedding, a new car, or even a property deposit.
If you’re thinking about giving an early inheritance, then you’ll need to think about how this may be affected by Inheritance Tax, and of course, how you plan to fund your gift.
Can I reduce Inheritance Tax if I give an early inheritance?
Inheritance Tax (IHT) is a tax paid on the value of your estate above a certain threshold when you die. Your estate consists of all of your assets, including your savings, your property, your investments, and so on.
The current inheritance tax threshold, also called the ‘nil-rate band’, is £325,000 and will remain at this level until at least 2028.
So if your estate is worth more than £325,000 in total (£650,000 if you’re married or in a civil partnership and one partner dies leaving everything to the surviving partner) the excess will be taxed at a rate of 40%. You can read more about the basics of Inheritance Tax in our guide Understanding Inheritance Tax.
Since IHT will have to be paid on your estate before any of it can be passed onto relatives (other than your spouse or civil partner), gifting an inheritance before you pass away can sometimes be a smart way of giving money away without a chunk of it going to the taxman. However, depending on how much time has passed between you giving a gift and your death, your loved ones may still end up needing to pay IHT on the gift.
The seven-year rule
Depending on when you give an inheritance, it may become a ‘potentially exempt transfer’ and be free of IHT. Basically, if seven years pass between the date that you give a large financial gift and the date of your death, then the recipient will not usually have to pay any Inheritance Tax. However, if you die within this seven year period, then the gift will be considered part of your estate and subject to Inheritance Tax (again assuming that the total value of your estate with all of these gifts exceeds £325,000).
Gifts given in the three years before your death are taxed at the full 40%. However, gifts given between three and seven years before your death are taxed on a sliding scale. This is known as ‘taper relief’. This is laid out below, showing what the tax rate is for each time period.
- 0 to 3 years: 40%
- 3 to 4 years: 32%
- 4 to 5 years: 24%
- 5 to 6 years: 16%
- 6 to 7 years: 8%
- 7 or more: 0%
Bear in mind that gifts that you still have an interest in, no matter when you’ve given them, won’t qualify as potentially exempt transfers.
For example, if you were to give your child your property, but carry on living in it without paying them any rent, the house would still be considered part of your estate and would be subject to IHT when you die. This is known as a ‘gift with a reservation of benefit’. You can find out more about potentially exempt transfers in our article Inheritance tax: what are potentially exempt transfers?
There are a few ways that gifts given within this seven-year timeframe may be exempt from Inheritance Tax. For example, individual gifts of up to £250 per person a year are exempt from IHT, as are other regular gifts made out of income.
For larger gifts, you also have a yearly “annual exemption” – this allows you to give away up to £3,000 each tax year without this being added to the value of your estate. You can split this allowance across multiple gifts or multiple people, and carry your allowance forward one tax year as well.
Exemptions also apply if the recipient is getting married or entering a civil partnership. For example, you can give £5,000 to your child, £2,500 to your grandchild or great-grandchild, or £1,000 to anyone else if they are getting married or entering a civil partnership. The wedding allowance can be combined with your annual allowance as well.
For a full breakdown of the types of gifts that are exempt from Inheritance Tax, read our article Which gifts are exempt from Inheritance Tax?
Should I leave an early inheritance?
While Inheritance Tax can be quite complex, as you can see there are a number of ways that a gift you give before you die can be exempt from Inheritance Tax – so, in many cases, it can be financially advantageous to give an early inheritance. If you are relatively young and healthy and are financially able to do so, then sooner can often be better for gifting an early inheritance, as your gifts are far less likely to be impacted by Inheritance Tax the sooner you give them. If nothing else, it is highly unlikely that gifting an early inheritance will see your loved ones paying more in IHT.
Of course, for many people the main reason for giving an early inheritance is that they want to see their loved ones enjoying the money, or having the stress of a big purchase alleviated. This may well take precedence over financial concerns for you, though you should make sure that your children or next of kin are aware of the IHT implications of any gifts that you give later in life, to avoid unexpected shocks later on.
The other main consideration should of course be whether you can afford to give an early inheritance. While it is always nice to be generous, you should never make a large financial gift impulsively, and you should think carefully about your own financial needs both now and in the future.
Passing on money after you have died is easier in a way, because you won’t need it any more at that point – but if you are still alive, then your financial circumstances can still change, which can make it difficult to choose the right amount to give. For example, might you or your partner have to think about paying for care in future, or are you likely to need to boost your retirement savings when you stop work?
Can I use my property to fund an early inheritance?
If you wish to give a large financial gift to a loved one but aren’t sure how to fund it, then one option could be to take a loan out against your property. You might choose to do this either via equity release, or by remortgaging.
Equity release is a unique financial product available to those aged 55 and over. Essentially, you take out a loan secured against the value of your property, but you don’t make repayments on it. Instead, both the loan and any interest built up are usually repaid after you die or move into long term care and your property is sold.
You could use the money acquired from releasing equity – which you can receive either as a lump sum or as a regular income – to provide an early inheritance. Equity release reduces the total value of your estate, so by releasing equity you could help minimise your inheritance tax (IHT) liability when you die.
Of course, releasing equity will affect what you can leave behind after you die, so it’s worth discussing it with your loved ones first. You can learn more about equity release in our article Equity release – what is it and how does it work?
If you’re looking for somewhere to start, you can get expert advice from a Rest Less Mortgages equity release specialist. They are active members of the ERC and can advise on equity release mortgages from the whole of the market. They’ll listen to your needs and talk you through your options, so you can decide if equity release is the right option for you.
Alternatively, you could look into remortgaging your property. If you are currently on your lender’s Standard Variable Rate (SVR), then remortgaging onto a different mortgage product could potentially reduce your monthly costs and allow you to budget for financial gifts.
For example, let’s say you want to release £30,000 of equity, and your current mortgage debt is £100,000. You might apply to remortgage £130,000, and use the bulk of this money to repay your old mortgage, leaving you £30,000 to gift your children. Your new mortgage balance will be £130,000, but if you’ve moved onto a more competitive mortgage rate, you might not see a big jump in your monthly costs even though you’ve borrowed more. It’s always worth speaking to a mortgage broker to work out how much you can release and what it’s likely to cost you.
Another option might be to consider a retirement-interest only mortgage, where you only pay back the interest on your loan each month, with the capital itself usually only being repaid when you die or move into long-term care and the property is sold. Find out more about some of the options that might be available to you in our guide Mortgages for over 50s: what you need to know and about using your property to fund an inheritance in our article Can I take money out of my property to give to my children?
Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage. If you’re looking for somewhere to start, you can speak to a Rest Less Mortgages advisor and get high quality advice on residential, retirement interest-only, equity release and buy-to-let mortgages.
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