Looking to give a loved one a helping hand? Maybe you want to help your child get onto the property ladder, or you want to help a grandchild buy their first car.
With big sums of money like this, it’s quite common for people to give their loved ones an ‘early inheritance’. It can help them to reach some big financial milestones and means you’ll be around to see them enjoy the gift. But there are some things you should think about first.
1. Remember there could be tax to pay
Gifting money to your loved ones can work both for you and against you when it comes to inheritance tax (IHT).
In some cases, gifting money can reduce the tax they’ll pay after you die. For example, if the amount you gift reduces the value of your estate to below £325,000 (known as the ‘nil-rate band’), then your loved ones wouldn’t need to pay IHT at all. That’s because you only need to pay IHT on an estate worth anything over £325,000.
In some cases, the nil-rate band could be more than this, but even if the gift doesn’t take the value of your estate below the threshold, it could still reduce the amount they pay. It could even potentially save them thousands.
However, it all depends on how long you live for after you give them the money…
The earlier you give it, the less tax they could pay
This is where things get a bit more complicated, so bear with us.
You can give up to £3,000 a year tax-free, which is your ‘annual exemption’. If you haven’t used the £3,000 from the previous year, you can carry it forward one year, taking your annual exemption amount to £6,000. But the value of any gift you make over this amount could be added to the value of your estate after you die, meaning your loved ones could pay up to 40% IHT on the excess.
How much tax they pay really depends on the amount of time that has passed between you giving the gift and your death. If you die within three years, the excess will be subject to 40% tax, but the rate of tax due goes down as more time passes. And normally once seven years have passed, no inheritance tax will be due at all.
|Years between gift and death||Rate of tax on the gift|
|0 - 3||40%|
|3 - 4||32%|
|4 - 5||24%|
|5 - 6||16%|
|6 - 7||8%|
|7 or more||0%|
Inheritance tax is complicated, and this is just a brief and simple summary of how you could reduce the amount of tax paid on any gifts you make. There are different rules, reliefs, and exemptions available to you depending on who and what the gift is for. But what we’re trying to say is: work out what gifting this money could mean for you and your loved ones. If you want more of a deep-dive on how inheritance tax works when it comes to gifting, read How much money can I gift to my children and grandchildren tax free?
2. Where are you going to take the money from?
You’ve done the maths and you’re happy with the tax side of things – now you need to decide where the gift’s going to come from.
If you’re retired and your main source of income comes from your pension plan, then that might be the obvious choice. Plus, you usually get up to 25% of your pension pot tax-free, which could help to cover the costs of a large gift.
If this is plan, there are a couple of things you should think about. First, just make sure that you’re not giving away anything you might need later. Your pension plan will need to last throughout your retirement, so make sure gifting this money won’t impact your quality of life in the years to come.
Second, your pension plan is actually one of the most tax-efficient ways to pass on your money to your loved ones after you die. This is because it’s not usually counted as part of your estate, so normally IHT doesn’t need to be paid on it. So, although your pension savings might be one of the best ways to give inheritance, they may not be the best way to give early inheritance. If you’ve got other savings, investments or extra income, they could be a better first choice.
Find out more about passing on your pension savings in Can you leave your pension savings to your loved ones?
3. Take notes!
Finally, keep a record of any money you decide to gift. When you die, the people managing your estate will need to produce evidence of any gifts made during the seven years before your death. So make a note of who the gift went to, how much it was for and the date you gave it. Doing this can help speed up the process and save the people dealing with your estate some headaches.
The information in this article should not be regarded as financial advice.
Pension plans and some types of ISAs are investments. Their value can go down as well as up and could be worth less than was paid in.
Your own personal circumstances, including where you live in the UK, will have an impact on the tax you pay and laws and tax rules may change in the future.
The information here is based on our understanding in November 2023.