Does Helping Your Kids Buy A House Impact Inheritance Tax?
The Bank of Mum and Dad is helping more and more children get onto the property ladder, as well as move up it. In 2018, Legal & General report, 1 in 4 UK housing transactions were dependant on the Bank of Mum and Dad. That’s the equivalent to a £5.7bn mortgage lender.
Most parents used cash savings to be able to help their family. But however they help, it’s not without implications:
- 10% admitted it left them feeling less secure about their own financial future
- 17% said they cut back as a result (giving up a holiday or putting off buying a new car)
If you’re able to help your kids, then it can be an amazing thing to do. But it shouldn’t leave you out of pocket. Before you commit, think about what it would mean for you.
One of the things you should consider is the tax impact of giving money to your children. Although it could be the only reason they’re able to buy a home, it’s important to be aware of the potential impacts – especially on things like inheritance tax.
With the UK’s inheritance tax receipts for 2017-18 hitting a record high of £5.2bn, it’s something many of us will be looking at. It’s natural to want to pass on as much of your estate as possible to your loved ones, without paying more tax than necessary.
Inheritance tax is the tax applied to assets acquired by gift or inheritance above the threshold. It was introduced in 1986 to replace capital transfer tax.
It applies to – and is paid by – your estate. When you die, the tax bill must be paid before anything can be passed on to your family and friends. A lot of people underestimate how much they have to leave behind. In fact, it’s one of the common reasons for not writing a will. But your assets includes things like:
- Property (including the furniture, technology and personal items)
- Any land
- Cash, investments and shares
- Cars
- Pensions
- Life insurance policies
These assets could have a lot of combined value. And if that value adds up to more than the threshold, the estate might owe inheritance tax.
It could impact what you give your children or grandchildren because if you give any money away before you die, it’s usually counted as part of your total estate. This means it’ll be subject to inheritance tax if you die within seven years.
While you can’t control the manner or time of your death, it’s definitely worth planning any gifts to minimise the likelihood of them being subject to inheritance tax.
The inheritance tax threshold is £325,000. If the value of the assets in the estate is above £325,000, it will owe inheritance tax of 40% on that amount. Debts are deducted from the value of the estate first. There is a ‘main residence’ allowance too, and you’ll only have to pay 36% if you leave at least 10% to charity.
Currently, you’re allowed to leave an estate valued up to £325,000 and an additional £125,000 for your main residence before being taxed, giving an allowance of £450,000.
The £325,000 threshold has been frozen until the 2020/21 tax year at least, and the residence allowance will be phased in until April 2020. It started for tax year 2017/18 at £125,000 and will increase by £25,000 each year until a total of £175,000 in 2020. That’ll make the total allowance £500,000.
This additional allowance is only valid on a main residence and where the person inheriting the house is a direct descendant.
There are exceptions to inheritance tax, though. For example, if you’re married, you can pass your full estate to your partner when you die without owing any inheritance tax. This also passes on your £325,000 threshold, making the estate’s amount free from inheritance tax a total of £650,000.
If you want to help before you die, you can try and gift money when you’re younger. So long as you don’t pass away within seven years, your estate won’t owe inheritance tax on that gift.
But we can’t plan our own deaths, and with many parents wanting to help their family, it’s important to take care over what gifts you make. Noone wants to pay more tax than they need to. With this in mind, the following rules are worth noting:
- You can give away £3,000 each tax year. The first £3,000 you give away doesn’t count as part of your estate. It wouldn’t be subject to inheritance tax even if you died within the seven year period. What’s more, if you don’t use this allowance, you can carry it forward for one year. Then you’d have a total of £6,000 to give away without being subject to tax.
- You can give away money from your income. Only your assets are subject to inheritance tax, so if you have an income (from a job or your pension), it’s exempt. You can give this money away regularly, but it shouldn’t affect your lifestyle. You’d need to be left with enough income to live comfortably without compromises.
- You can gift more money on special occasions. If your son or daughter is getting married, you can give them money without worrying about inheritance tax. You just have to make sure it’s gifted shortly before the marriage, or on the day of, and be aware of the limits for different family members:
- Parents can give their children £5,000
- Grandparents can give their grandchildren £2,500
- Everyone can give £1,000
There are some details you’ll need to be aware of before you give any money away. For example, the wedding or civil ceremony has to go ahead for the gift to be exempt from inheritance tax. Most gifts have also got to be unconditional – a parent couldn’t lend the money and expect anything back in return.
Similarly, if you wanted to give money from selling your own house to your children, it wouldn’t count as a ‘gift’ if you then moved in with them, gave them the money or joined resources to buy together. They could still end up paying inheritance tax, even after the seven year rule, because it counts as a ‘gift with reservation of benefit’. That’s why it’s always best to plan and figure out what you can and can’t do.
As a parent who would like to help out their family, what can be done? Firstly, it’s important to remember you can leave as much as you want to your family and friends. It’s completely up to you. But it is natural for many people to want to reduce the potential tax bill.
Planning gifts to reduce any potential inheritance tax bill is a good place to start. After all, whatever you can do to decrease the overall value of your estate, it means less of it will be subject to inheritance tax.
When you make a gift (in addition to the exemptions mentioned above), it is called a Potentially Exempt Transfer (PET). That’s because, until seven years have passed, it’s unclear if you’ll pass away and inheritance tax will be due on it.
If you do die within the seven year period, the gift is then called a Chargeable Transfer.
For Chargeable Transfers, inheritance tax might need to be paid. It will be charged at the full 40% if the death happened in the three years following the gift. But if the gift was made three to seven years before the death, the amount of tax is worked out on a scale known as ‘taper relief’.
| Years between gift and death | Tax paid |
| Less than 3 | 40% |
| 3 to 4 | 32% |
| 4 to 5 | 24% |
| 5 to 6 | 16% |
| 6 to 7 | 8% |
| 7 or more | 0% |
| Source: Money Advice Service | |
As an example, if you gave a gift of £500,000, it could work out as follows:
- It would use up the £325,000 allowance
- The remaining £175,000 would be subject to inheritance tax
- Taper relief may apply – say the gift was given between four to five years ago, the tax due would be 24%
- The bill owed on this gift would be £42,000
- Inheritance tax would still need to be paid on the rest of the estate
To make things easier to work out, it’s best to start keeping a record of what money you give away. It’ll help the executor of your will determine what parts of your estate might be taxed. Money Advice Service recommend making a note of:
- What you gave (money or physical asset)
- How much it’s worth
- Who you gave it to
- And when you gave them the gift
With large potential bills, investigating ways to reduce the price your estate has to pay could result in huge savings. Inheritance tax is a reality, but effective estate planning prevents unnecessary payments. In addition to the options explored above, you can:
- Leave money to a charity. By donating money to charity, you can reduce the rate of inheritance tax from 40% to 36%. You have to donate at least 10% of the value of your estate at the time of death. And although 35% of people say they would leave a charitable gift in their will, only 7% do, so it’s something more of us could consider to remember a cause that’s important to us and save money.
- Give gifts to other people. You’re allowed to give as many gifts worth up to £250 as you want. Just make sure it’s not the same people you’ve gifted your £3,000 annual exemption to. In all other cases, these £250 gifts won’t be subject to inheritance tax. It can bring down the value of your estate overall, and reduce the amount which could be liable to tax.
- Investigate trust options. When you put money into a trust, if certain criteria are met, it doesn’t count as part of your estate. So you could set up a trust for your grandchildren’s education, for example, and it might not be part of the inheritance tax bill. But do be wary, because rules around trusts are complicated and it’s important to get expert advice.
Investigating all your options with a qualified advisor is the best way to make sure you stay within the rules and don’t end up with a larger bill than necessary. For example, if any of your beneficiaries made income from any gift or trust, it could be subject to Capital Gains Tax.
There are also some exceptions to be aware of. The following could allow assets to pass on without inheritance tax, or with a reduction to the normal amount:
- Business relief. You can get 50% or 100% tax relief on some business assets. These can be passed on in a will or while you’re still alive. This relief does depend on how you own the business and what type of business it is.
- Agricultural property and assets. If your estate includes a farm or other agricultural assets, and they meet the criteria, you can pass it on without any inheritance tax.
- Woodland property. The land itself is not subject to inheritance tax, but an executor must include the value of the woodland when applying for probate. If the trees were sold or given away, that could be subject to tax.
- Heritage assets. If your estate includes assets of national scientific, historic or artistic importance, you could get relief from inheritance tax. Examples include famous works of art or land with outstanding natural beauty status.
To get these kinds of relief, you must meet government criteria. When you’re planning how to pass on your estate, be sure to check out what assets meet the conditions.
Your estate is responsible for paying inheritance tax to HM Revenue and Customs (HMRC). This responsibility falls to the executor of your estate, emphasising the need to write a will and include clear instructions for them. They have a year from the date of death to fill in the inheritance tax forms, but the estate can start getting charged interest after six months.
There are various ways to pay the bill, but you need an inheritance tax reference number from HMRC at least three weeks before you start to pay. You can apply online, or by post using the application form IHT422.
Once it has been paid, the executor can start to distribute the assets as set out in the deceased’s will.
Without a will, default laws set out by the government will be used to decide how your estate should be managed and distributed. These laws might not reflect your wishes and the estate could end up paying more inheritance tax than it would have with effective planning.
To shape the future of your estate after death, create a will and start planning how to distribute your estate.
Inheritance Tax and probate enquiries
https://www.gov.uk/government/organisations/hm-revenue-customs/contact/probate-and-inheritance-tax-enquiries
Gifts and exemptions from Inheritance Tax
https://www.moneyadviceservice.org.uk/en/articles/gifts-and-exemptions-from-inheritance-tax#are-there-any-reliefs-from-inheritance-tax
Inheritance tax: what is the limit and how has it changed?
https://www.telegraph.co.uk/tax/inheritance/inheritance-tax-what-is-the-limit-and-how-has-it-changed/
Inheritance Tax (IHT): Plan to legally save £100,000s on your estate
https://www.moneysavingexpert.com/family/inheritance-tax-planning-iht/