Introduction to Gifting
We want the best for the children in our lives. We want them to be able to chase their dreams and achieve their goals. As parents, grandparents, aunts or uncles, how can we help?
Giving a gift can usually be a good way to help. Giving a financial gift is one which children can appreciate over the longer term, rather than that new Funko Pop toy which might end up down the back of the sofa in a week's time! If done the right way, financial gifts can also be tax efficient and reduce any inheritance tax that might need to be paid when you pass away.
This guide explains everything you need to know about gifting, all the allowances available to you and inheritance tax. So let’s start with the question on everyone’s lips.
Please note that the tax allowances in this guide relate to the tax year 2022/23.
What is Inheritance Tax?
When your time in the game of life is up, the government adds up all your money, property and possessions that you leave behind and call it your “estate”. They then look at the value of your estate and use it to work out how much tax is owed on that value. That’s Inheritance Tax (IHT).
The amount of inheritance tax you have to pay is dependent on the value of your tax-free threshold and the value of your estate.
By default your tax-free threshold is £325,000. This means that you can leave up to this amount in your will and no inheritance tax will need to be paid. However you can increase your threshold to £500,000 if
- You pass your main residence (the home where you live in) to your children (including adopted, foster or stepchildren) or grandchildren when you die; and
- Your total estate is worth less than £2 million
To reduce (or remove) IHT, a lot of people try to pass down their assets when they’re still alive. But it’s not that easy. The government created a set of rules to only allow financial gifts to be given away tax free if they meet certain gifting rules.
What counts as a financial gift?
The basic idea of a financial gift is the same as any other kind of gift — it’s giving something to someone which they can keep or use for themselves. This can include a bunch of things like;
- Money
- Jewellery or any other personal goods
- A house
- Illiquid investments (think a car, some art, or that extra rare pokemon collection you saved from your childhood)
- Stocks and shares in companies
- Unlisted shares you held for less than 2 years before you died
But you have to be a little careful with some other gifts as well - like if you “sell” your house to a child for a nominal value. HMRC can see right through that and so will look at the difference between the market value of the house and what your child actually paid for it. That difference will also be counted as a financial gift.
Whilst the basic idea of a financial gift is the same as any other gift, because the gift has real value in terms of money, it can come with some strings attached…. Tax. With most financial gifts, if you pass away within 7 years of giving them, then the person who received the gift will have to pay a certain amount of inheritance tax.
Don’t worry though, the government has designed a bunch of different rules to help limit the amount of tax, if any, you have to pay on gifts. So let’s run through them all.
Annual gifting allowance
The first allowance that you have available to you is your annual gifting allowance. This is effectively a sum of money that you can give away each year without having to worry about tax being paid on it when you pass away. For the current tax year (22/23) this amount is £3,000 and you can use it however you like. Here’s a few different ways you could use it but there’s plenty more;
- Use it all to give to one child or grandchild
- Split it across all your children/grandchildren
- Give £2,900 to your favourite (not that we condone favourites) and the remaining £100 to the one that never listened to your advice
However you choose to use your £3,000 annual gift allowance is entirely up to you!
Another point to remember is that you can actually carry this allowance over for one year. So if you didn’t give any gifts in the last tax year then your allowance for this tax year would be £6,000.
Small gift allowance
You’ve used up all your annual gift allowance, now what? Fear not, you have another allowance known as the small gift allowance and that works like this.
You’re allowed to give as many gifts of up to £250 per person to as many people as you want. This resets every tax year and is a great way of sending smaller gifts without having to worry about inheritance tax. So if you’ve got a large number of children and grandchildren then this might work well for you.
Can I use my small gift allowance to someone who has already benefited from my annual allowance?
No, the small gifts can only be sent to people who haven’t benefited from any of your other allowances. Here’s a few examples of how these two allowances work together.
Example:
Arnold gifts £2750 in Christmas to his daughter (Jane), and £250 to his grandson (Billy). He thinks he’s used up one small gift allowance but still has £250 left in his annual gift allowance.
On Billy’s birthday (in January), Arnold wants to send Billy the remaining £250 from his annual gift allowance.
As soon as you gift someone more than £250, they count towards your annual allowance. The fact that Arnold had already sent Billy £250 means that if he makes the £250 birthday payment as well, he’s gifted £3,250 this tax year (Jane £2750 and Billy £500). This means that £250 would not be inheritance tax free if Arnold was to pass away in the next 7 years.
Gifts for weddings and civil partnerships
Attending a wedding or soon? Well allowance number 3 can help you gift tax free.
If it’s your child getting married, then you can give a gift of up to £5,000 and it won’t be subject to any tax if you were to pass away. Cheers!
If it’s a grandchild or great grandchild getting married then the allowance is a little bit smaller. The maximum you can gift to them (IHT free) for their wedding is £2,500. And for any other relative or friend, it’s £1,000.
Can I use the wedding gift allowance to someone who has already benefited from my annual allowance?
Yes, the wedding gift allowance doesn’t count towards your annual allowance. That means you can give your child a gift of £5,000 on their wedding day, and another gift of £3,000 in the same tax-year without having to worry about leaving them a hefty Inheritance Tax bill if you passed away.
Phew! Nobody wants a wedding gift that ends up costing them money.
Regular gifting allowance
The final, and can be one of best allowance to reduce inheritance tax, is the regular gifting allowance. If you’ve got surplus income after your salary (or pension) and you use it to make regular payments, then there’s no limit to how much you can gift tax-free. We could’ve started with this rule to save you reading the rest of the post but where’s the fun in that?
There’s two key things you need to be careful of if you’re using this allowance
What is surplus income?
Surplus income is any remaining money you have after all of your outgoings have been paid (e.g. your mortgage, bills, groceries etc). Money that effectively you don’t need to maintain your standard of living and would just go sit in your current account or go into your savings account, investment account or something like that.
In this definition, income has a pretty broad meaning. It’s not just your salary or pension, it also includes interest, dividends, rental income and other investment income. The two forms of regular payment that don’t count as “income” under this definition are;
- Regular withdrawals taken from a life assurance bond
- If you’ve specifically purchased life annuity
We briefly mentioned “maintain your standard of living” and this is really important in this context. If you’ve made changes to your life to create this surplus income (maybe you go on fewer holidays, you eat out less or you shop at less expensive restaurants) it will be a bit harder to prove that you didn’t actually need this money.
Disclaimer: But if you're unsure what counts as surplus income, best to be safe and speak to a tax adviser.
What do I need to do to prove it’s a regular financial gift?
The easiest thing to do to prove that it’s a regular gift is to set up a Direct Debit or Standing Order. This way, even if the worst was to happen and you were to pass away tomorrow, it can still be proven that you had the intent for this to be regular.
The regularity here doesn’t actually matter as long as the intent is there. It can be weekly, monthly or even annually. Just make sure it can be proven that it wasn’t a one off.
If you really are set against setting up a Direct Debit / Standing Order then another thing you could do is write a letter stating your intent (just make sure it doesn’t get lost). This way you can document in it how often you plan to make this payment and how much it’ll be. In this scenario you’ll need to remember to actually make the payment though as missing any payments could really hurt your case if HMRC was to ask your family questions.
Can my regular gift change over time?
Yes. HMRC recognises that some situations change. For example maybe your income could drop as your dividends reduce or you work less days. In that case it’s natural for your surplus income to change.
On the other side, if those regular gifts are to pay for a grandchild’s school fees or a child’s mortgage/rent, those can change too. They can increase due to inflation and so your payment may change from time to time.
Because of these reasons, the value of your gift is allowed to change over time.
How will my family know all this when I pass away?
After your innings is over, the executors of your estate (i.e. the people who make sure that your will is actioned in the right way and that all IHT due is paid) will need to complete some documentation to HMRC to show your income and all your gifts over the last 7 years.
To help them with this, it’s best to start recording this information. Everytime you make a gift, record its date and amount (we know an app that helps you with this if you’re gifting to under 18s). If you’re making regular gifts, make sure your Direct Debits are also tracked or at the very least you’ve written a letter. And finally, make sure your will (or a family member) is aware of where this record is.
By having this information, it’ll make their lives a whole lot easier and save some unwelcome surprises.
What happens if I exceed these allowances?
Technically speaking you can gift as much as you like, so first thing’s first - don’t worry. However, if you exceed your allowances, some of this might not be tax free. Whether it’s tax free or not depends on the 7 year rule.
What is the 7 year rule?
If you survive 7 years after a gift is made, then no inheritance tax needs to be paid on that gift. So you could gift £1m today and as long as you live at least another 7 years you’re OK. If you die within 7 years then some inheritance tax will need to be paid. The exact amount you’ll need to pay depends on how long you lived after you paid the gift. It works on a slide scale as follows;
Examples
If you’ve got this far then congrats. You must be really into your inheritance tax and gifting allowances.
To make sure you’ve fully understood, here’s a few hypothetical examples. Remember that with tax your personal situation might be different and these examples are just designed as a guide rather than something you should rely on.
Example 1:
Josh gives his niece Meera a gift of £20,000. Josh dies three and half years later and leaves an estate of £1.2 million pounds.
As the estate is over £325,000, any money gifted within the last 7 years will be subject to IHT. As Josh died three and half years later after gifting the £20,000 pounds to Meera the tax owed is 32% rather than 40%.
Josh at the time of the gift had a £3,000 gift allowance meaning only £17,000 is taxed at 32% leaving a bill of £5,440.
Example 2:
Kash gifts £250 to his 4 grandchildren as small gifts. He also gifts his daughter £2,000 at the same time. Two months later (but still in the same tax year) Kash decides that he wants to gift another £1,000 to his oldest grandchild for passing their A-Levels.
If Kash gives £1,000 then in total he will have gifted his oldest grandchild £1,250, which would not qualify for the small gift allowance. As he has also gifted £2,000 to his daughter this means that he will have gifted £3,250 (over the £3,000 annual gifting allowance).
Kash will need to survive for 7 years in order for the £250 to be free of IHT.
Example 3:
Roberta gifts £10,000 to her son and at the same time sets up a direct debit for her grandson’s investment account of £350 each month as she has some cash left over each month from her pension payments.
Roberta passes away 6 and a half years later and leaves an estate of £1.5 million. As Roberta passed away 6 and a half years after making the gift, her son will need to pay 8% in IHT (rather than 40%). However, Roberta did have £3,000 annual gifting allowance that year so the inheritance tax is only due on the remaining £7,000. Therefore the IHT due is £560 (£7,000*8%)
Although the money gifted into her grandson’s investment account was £35,100, as this was a regular gift then no IHT needs to be paid.
Recap / Outro
And that’s it – your 101 to gifting is done.
Financial gifts hit two birds with one stone – not only are they a great way to give money to loved ones, but are also a great way to manage your finances and reduce any future tax burden for your loved ones.
And finally, if you want a bit of a refresh on all those numbers, see our handy table below.
Disclosures:
Don’t forget, when you invest your money is at risk. You might end up with more than you put in - or you might end up with less. Remember that what you’re taxed depends on your own personal situation, and that can change in the future.
This blog isn’t our advice, so please don’t change your plans or buy or sell any of your investments based on it. We don’t know your money situation, your plans for the future or how much experience you’ve got. If you’re unsure you should speak to a professional financial advisor
Sources:
https://www.gov.uk/inheritance-tax/gifts
https://www.gov.uk/guidance/work-out-inheritance-tax-due-on-gifts