How to provide an early inheritance for your family

If you have assets you always imagined you’d pass down to family members, perhaps so that your grandchildren could buy a first home or pay for university education, you could be in for a wake-up call. 

Thanks to the baby boomers, there’s an “inheritance boom” so-called because, as a result of benefiting from house price rises, many of today’s over sixties are likely to have significant assets to pass on to their children. However, increasing longevity means that the children of baby boomers are receiving their inheritance much later than they used to. They are, in turn, likely to live longer, meaning that the youngest generation – today’s grandchildren - could well end up without any inheritance until well into their own retirement – after they’ve passed all the life milestones where, perhaps they could have used a bit of a leg up.

It might be worth thinking about whether you’d like to offer a “living” inheritance

This inheritance boom also means a lot more potential revenue for the Treasury. Increasing property wealth is dragging more and more baby boomers above the inheritance tax (IHT) threshold. Leaving assets to beneficiaries when you die means more of your cash will go to the taxman than if you give away some of your assets while you are still alive, potentially avoiding an IHT bill.

It might, therefore, be worth thinking about whether you’d like to offer a “living” inheritance to children or grandchildren before your death, and about how to organise your assets to do this.

There are many benefits to transferring wealth down the generations earlier, not just reducing the inheritance tax bill on your estate. 

Why offer early inheritance?

IHT can result in the taxman taking quite big chunks out of your estate when you die. The current threshold, or maximum value of an estate that can be passed on tax-free, is £325,000. If you are passing on the family home, the threshold is £425,000. For a married couple (or on the death of the surviving spouse), the threshold is £650,000 (2 x the individual threshold), or £850,000 in the case of a home being passed on. Anything over the relevant threshold is taxed at 40 per cent.

You can reduce the value of your estate that would be liable for IHT before you die by gifting cash in your lifetime.

If you gift cash to younger relatives at least seven years before your death, it will not be liable for IHT.

If you die within seven years of making the gift, the IHT is subject to taper relief depending on how long ago the gift was made.

There’s an annual exemption on any gifts up to £3,000 to an individual. 

You can also make wedding or civil ceremony gifts up to £1,000 without this being considered part of your estate (you can find more details of exemptions here).

How ISAs can help

One of the easiest ways to pass on cash gifts as an early inheritance is by using money stored in an ISA.

ISAs are investment vehicles that allow you to invest up to £20,000 a year tax-free.

You can use the money you have been building up in ISAs throughout your working life to help younger family members with big living costs, such as paying tuition fees or buying a house, and benefit from the exemptions mentioned above on gifting.

If you want your ISA money to pass to beneficiaries, it is much better to gift it earlier, while you are alive, and potentially mitigate IHT, rather than allow the funds to be passed over after you die – because if this happens, then IHT would be payable.

You can do this by selling some of your ISA holdings if you have a stocks and shares ISA. The funds can be in your account within a few days (there is usually a small percentage charge for selling stocks and shares). If you wanted to make use of your £3,000 annual exemption, you could withdraw and gift this amount to beneficiaries annually.

However if you want your ISA funds to pass to your spouse when you die, you don’t need to worry about IHT at all, as anything that is handed over to a surviving spouse remains tax-free.

If you wish to top-up your grandchildren’s savings with your ISA money, you could also contribute to their tax-free junior ISAs, which they can access from the age of 18, or to their Stocks and Shares, Lifetime or Help to Buy ISAs, if they are older and are using these savings vehicles.

Could I gift money using my pension?

The rules for pensions are a bit different. With pension funds, it makes sense to leave these invested rather than gifting them, because pensions can be passed on to beneficiaries, including a spouse, without attracting an IHT bill if the pension holder dies before 75. After 75, any income taken by the beneficiaries from the pot will be taxed at their usual income tax rate.

Because of the different IHT liabilities of funds held in an ISA rather than a pension, it’s usual to use money kept in an ISA for income or gifts to relatives before making withdrawals from your pension pot when you retire.