What to think about before agreeing to give an early inheritance

Elderly man with his young grandchild

Many parents would like to support their adult children by giving an early inheritance – and many children would appreciate a financial boost – but what’s involved?

By Steve Smethurst

Parents and grandparents often want to help their children and grandchildren get on the property ladder, but don't know how to do it. Should they simply give them money or property gifts? The possibilities are endless.

One of the big factors in this scenario is inheritance tax (IHT), the 40% tax on the estate that's paid when someone dies - that includes things like property and gifted money from parents. It applies to the assets of an estate above £325,000 (£650,000 for married couples or civil partners). 

Once derided as the ‘death tax’, it’s now the scourge of the ‘accidentally rich’ – families whose property values have rocketed over their lifetimes, and who don’t want to see a big chunk disappear in tax.

The seven-year rule

If you make ‘early inheritance’ gifts seven or more years before your death (‘the seven-year rule’), the giftee won't have to pay IHT. The people you give gifts to will be only be charged IHT if you give away more than £325,000 in the seven years before your death, although only the balance over £325,000 will be taxed retrospectively.

You can give away £3,000 worth of gifts each tax year without them being added to the value of your estate.

However, if you die within that period, there’s a sliding scale of liability. For example, they’d pay 40% if you died within three years, and 24% if it was between four and five years. It’s also worth noting that you can give away £3,000 worth of gifts each tax year without them being added to the value of your estate. 

Using your home to support them now

Another option is to look at equity release. It's essentially a way for homeowners to unlock cash from the value of their home once over the age of 55. The most common form of equity release is called a lifetime mortgage, which is a long-term loan secured on your home. It's usually repaid from the sale of your home when you pass away or move into long-term care, subject to the lender's terms and conditions. You can take the money you release as a lump sum, or a lump sum with a cash reserve where smaller amounts can be taken.

This might be an option if you want to support your children while you're still here - allowing you to see the difference it's made to their lives. For example, you might want to use the money you release from your home to buy property gifts for family members who may not be able to afford to get on the property ladder themselves. Or you may want to gift money to help your loved ones buy a place of their own - so you can enjoy it with them too. 

It's worth remembering that releasing equity from your home may affect your tax position and the means-tested benefits you're entitled to. It'll also lower the amount of inheritance you can leave behind so it's important to discuss it with your family first. The money used to repay the loan won't be part of any inheritance, so won't be subject to IHT.

Record-keeping is key

According to the government's MoneyHelper Service Footnote [1], if you're planning to give away money or assets to reduce IHT, it's important to make a record of what you gave, who you gave it to, when you gave it and how much it's worth.

It might also make things clearer (in legal terms, at least) if parents or grandparents should ever want their gift back. The legal definition of a gift is “the voluntary transfer of property from one individual to another made gratuitously to the recipient”. 

The word ‘gratuitously’ means that the giver of the gift must be happy at the date they made the gift that they made it without receiving anything in return. A legal agreement would otherwise be necessary to specify any conditions on the ‘gift’.

Many people will also insure their life – ensuring a cash pay-out for dependents on their death – but as the average age of inheritance is 61, this may not immediately help any children who may want to enjoy many more years with their parents as well as getting a foothold on the housing ladder.

Make a record of what you gave, who you gave it to, when you gave it and how much it's worth.

All rules are subject to change

What’s clear is that while IHT is here, for now, the pressure is on for a change. Some countries, such as Japan, have high rates of IHT to pay for the ageing population. Others, such as India, Austria, Hong Kong, Sweden, Canada, New Zealand and Australia have no inheritance tax on death. The UK may well change its rules in future, so make sure you keep an eye out for any alterations to inheritance rules.

For more information on IHT and probate, visit gov.uk or call the government helpline on 0300 123 1072.

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