How to reduce your IHT bill by gifting

Inheritance tax bills can be complex, but passing on some of your wealth to your children by gifting can help reduce how much of your estate ends up with the tax man. Lisa Conway-Hughes, a qualified financial adviser, explains how to keep your IHT bill low.

Smiling senior couple talking while sitting with Real Estate Agent in office
(Image credit: © Getty images)

The rules and regulations around inheritance tax (IHT) are notoriously tricky, and rising property prices mean more of us could be liable.

But there are a number of practical steps that can help lower your IHT bill while supporting your family or causes close to you.

Lisa Conway-Hughes, a qualified financial adviser, explains how to keep your IHT bill low.

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Quick wins to reduce your IHT bill

Before we dive into the complex, let’s start with the quick wins that can help keep your IHT bill low:

  1. Gift £3,000 each year. This is called the ‘annual exemption’ and if you didn’t use your allowance last tax year you can also carry this allowance forward – so, you can make £6,000 as a gift. Each person gets an allowance, so as a couple looking to gift to children/grandchildren you would have £6,000 each year.
  2. It must be part of your normal expenditure – typical or habitual – like a monthly gift
  3. Must be out of income. Common sources are income from employment or self-employment, rent, pensions, interest, and dividends
  4. The gift must not deprive you of your normal standard of living
  5. You are allowed to make gifts of up to £250 to as many people as you like if you haven’t made any larger gift to that person (for example, the £3,000 mentioned above).
  6. Each year the rules allow you to gift a lump sum to someone getting married or starting a civil partnership. For children you can gift £5,000, for grandchildren and great-grandchildren the allowance is £2,500 and then £1,000 to anyone else.
  7. You can also gift an unlimited amount of money without paying IHT at 40% if you live for more than seven years afterwards.

What Are Your Children’s and Grandchildren’s Needs?

It is always worth taking a step back and thinking about what you are trying to achieve with the gift? Some things to consider are:

  • What would benefit the children the most?
  • When do they need the money?
  • Do you need to/want to gift to each child equally?
  • Do they need an income or a lump sum?
  • Do they need the money/should you just take the trip of a lifetime?
  • How would you feel if they didn’t fulfil your wishes with the gift?

When it comes to needs, we all know that younger generations often struggle with getting on the property ladder but very rarely does their longer-term financial planning get a thought. For example, are they likely to be able to invest sufficiently to have a good standard of living in old age?

Did you know that you can pay into pensions for your children and grandchildren even if they are still children themselves? Yes, even a new-born (without an income) can have a pension and get tax relief of 20% on contributions of £3,600 gross per annum – this means a net contribution of £2,880. If you were to pay this amount into their pension from birth until age 25 and then the pot was left to grow at 6% pa (with fees of 0.5%) then the pot at age 57 could be worth £1,077,731 and if they delayed their retirement to age 65 could be worth £1,653,979.

We can take this example one step further too. Let’s say you have a child who earns £60,000 and they are married to someone who earns £30,000. Together they have a toddler and a baby. As your child is earning £60,000 or more, they would have their child benefit fully clawed back by way of the High Income Child Benefit Tax Charge. On top of this they are also paying 40% tax on nearly £10,000 of income.

If you felt that you could contribute to a pension for them you could help to reduce their taxable earnings which would mean that they would start to be able to keep some/all child benefit. If you were to pay in £10,000 gross into a pension for your child, their taxable earnings would be reduced down to £50,000 – this would remove the High Income Child Benefit Tax Charge fully. For the eldest child this is £21.80 per week (set to rise next tax year to £24 pw) and £14.45 per week for the second (set to increase to £15.90). This is £1,885 of tax free income extra for the young family per year.

On top of this your child’s pension is better off each year too. But there is still more. Because of basic rate tax relief, the £10,000 has actually only cost you £8,000. The other £2,000 has automatically been added to the pension in tax relief.

But there is more still; your child will need to do a tax return because they have paid 40% tax on all their earnings above £50,270 but only received 20% back in tax relief via the pension. The government will owe them £60,000 - £50,270 = £9,730*20% = £1,946.

The total extra in their pocket will be £3,831, their pension will be better off by £10,000 and you will have reduced your estate by £8,000 too.

However, before gifting any money, it is so important to make sure that you truly can afford to gift it. I can’t stress enough the importance of a lifetime cashflow plan on ensuring that you have peace of mind when you do gift.

Lisa Conway-Hughes

Lisa Conway-Hughes is a chartered financial adviser and a fellow of the Personal Finance Society. Lisa joined the financial industry 16 years ago and in October 2020 was voted Financial Adviser of the Year – London by Professional Adviser Magazine – WIFA.

Lisa, also known as Miss Lolly, writes, speaks, tweets, and blogs on all things money related. Lisa is passionate about making financial education open to all and loves taking the jargon out of the financial world. Lisa is the author of Money Lessons and features regularly as a media expert in the female press and newspapers as well as having been interviewed by the BBC News.