Forget the bank of mum and dad – it’s now grandparents who are dipping into their savings to help their grandchildren buy their first home.
As house prices continue to soar and wages remain stagnant, more are stepping in to support the younger generations, handing over tens of thousands of pounds as early inheritance gifts.
However, if they’re not careful, they and their grandchildren could get caught out by an inheritance tax (IHT) trap with a bill running into thousands.
THE INHERITANCE TAX GIFT TRAP – AND WHO GETS TO PAY IT
If your estate – which includes the gifts you’ve made in the last seven years – is below £325,000 (known as the nil-rate band), you can give money to your grandchildren without fretting about them ending up with a chunky IHT bill.
If you tip over this, inheritance tax at 40 per cent can be charged on a previously gifted home deposit. The bill would end up payable by the grandchild who received the money, explains Rachael Griffin, tax expert at wealth manager Quilter.
Gifts are considered in chronological order. Take a grandmother, for example, who has used up £300,000 of her nil-rate band making gifts to three of her four grandchildren in the past couple of years.
She then makes a further £100,000 gift to her final grandchild for a house deposit and dies that year. It is this last gift that goes above the £325,000 nil-rate band. So the fourth grandchild must pay the tax due – 40 per cent on £75,000, in this case, or £30,000.
As the grandmother’s entire nil-rate band has been used up by gifts, any remaining estate will be taxed in full at 40 per cent. This is paid out of the estate.
If, however, the grandmother gave away only £100,000 to one grandchild as a gifted deposit in the years before she died, the grandchild does not need to pay IHT.
Instead, it counts against her estate after death, so less money can be passed on tax-free. The example above presumes the grandmother only benefits from the standard £325,000 nil-rate band.
If you own your home and leave it to a direct descendant, then you have an extra £175,000 allowance called the residence nil-rate band. In this case you could make up to £500,000 of gifts in the years before you die before IHT begins to be levied.
Plus, as spouses can transfer their unused allowances between each other, there may be some left over if the grandmother’s husband had previously passed away and not made any gifts.
GIFT EARLY TO BEAT THE SEVEN-YEAR RULE
There is a simple way to cut to zero the death duties due on a gifted house deposit – make the gift early.
If you gift £100,000 to your grandchild and then live for a further seven years, it falls outside your estate under the ‘seven-year rule’. There’s no tax bill to worry about from the gifted deposit.
But if you die within those seven years, your grandchild or estate could be lumped with a hefty tax bill. There is, however, a ‘taper relief’ system which means the closer to the full seven years you survive, the less tax is charged.
For a property deposit gifted in the three years before death, the full 40 per cent rate will be levied. But any gifts made three to four years ago will be taxed at 32 per cent.
If it’s four to five years ago, there’s a 24 per cent charge, while gifts made five to six years before your death have a 16 per cent IHT rate. Those given six to seven years ago are charged at a minimal 8 per cent.
HEALTHIER GRANDPARENT MAKES THE DONATION
Ms Griffin says: ‘The healthier person could make the gift. Think about who is the right person to make the donation – but you want to make sure you’re using all your allowances first.’
If the grandparent in better shape gives the deposit, there’s more chance of the donation falling outside of the estate after seven years.
GIVE AWAY UP TO £3,000 TAX-FREE EVERY YEAR
Everyone gets a £3,000 annual gift allowance which does not count towards their estate – even if they die within seven years. Plus, if you didn’t use this year’s allowance you can carry it forward to the next tax year, but no further.
This means that a couple could give away up to £12,000 completely free of IHT in one tax year, and a further £6,000 every year after that.
There’s also a smaller £250 tax-free allowance which you can give to as many people you like, but only one per person and not to the grandchild that also received your tax-free £3,000.
USE SPARE INCOMETO GIFT AN UNLIMITED AMOUNT
Rachael Griffin, tax expert at wealth manager Quilter, suggests the grandparent in better shape gives the property deposit, as there’s more chance of the donation falling outside of the estate after seven years
There is one nifty trick you can use which is one of the most generous – and under-utilised – available, according to Ms Griffin.
The so-called gifts out of normal expenditure allowance means that you can gift an unlimited amount to your grandchildren for their house deposit without landing them a tax bill. However, there are strict criteria you need to meet to claim the exemption.
These must be regular payments, come ‘from regular monthly income’, according to HMRC, and in no way impact your normal standard of living.
Jordan Gillies, of wealth manager Saltus, says: ‘The number and size of gifts out of excess income that someone can make with no IHT implications are effectively unlimited.’
For example, you could gift £10,000 a year out of your excess pension and investment income for six years before your grandchild begins their search to buy a house. By the time they are ready, they’ll have a healthy £60,000 to put towards their property.
There are no hard and fast rules on the length of time over which gifts must be made to count as regular. But Ms Griffin says: ‘It’s mostly a given that if you gift over more than three years, that will heed the rules.’
If you plan on using this allowance, then good record-keeping is essential. Write a letter which states how much and how often you intend to gift and keep it with your will.