A gifting strategy can be a relatively straightforward way of avoiding Inheritance Tax providing you survive seven years from the date you make the gift.
Inheritance Tax is definitely something you need to be aware of and have a plan for as 40% of your wealth above applicable allowances will be lost to this tax.
Gifting money to your children ensures more wealth remains in the family rather than paid to HM Revenue and Customs.
Why stop at just avoiding Inheritance Tax though? How about a gifting strategy that provides you and your children with a combined 90% in tax savings?
A gifting strategy that generates 90% tax savings
A normal gift of money directly to a child will potentially save 40% Inheritance Tax if you survive seven years.
In fact there is a gifting allowance of £3,000 per year which doesn’t require you to survive seven years.
So a couple could give up to £3,000 in total each to their children every year and as soon as the gift is made it would be outside their estate for Inheritance Tax purposes. Anything above this amount and the seven year rule will kick in.
Making a larger gift to a child directly not only requires the survival of seven years but also may not be appropriate if you don’t feel your child is ready for a larger gift. Perhaps they are not yet responsible enough with money?
Well why not gift them money into their pension instead?
A gift into a pension not only saves 40% Inheritance Tax but your child can earn 20% basic rate Income Tax relief and a further 20% if a higher rate tax payer. So 90% in total tax savings.
Let’s look at an example.
Chris and Julie have total wealth in excess of £2 million. All of their spending is covered by their pension income so they are keen to pass their wealth onto their children to avoid Inheritance Tax.
They make an £8,000 gift to their daughter Kelly’s pension.
This pension provider will automatically apply basic rate tax relief, therefore topping up the contribution to £10,000.
As Kelly is a higher rate tax payer she will also be able to claim a further £2,000 in Income Tax relief.
So total tax savings:
- Inheritance Tax saved 40% of £8,000 = £3,200
- Basic rate Income Tax relief £2,000
- Higher rate tax relief £2,000
- TOTAL TAX SAVINGS = £7,200 (90% of the original £8,000 gift)
How a pension gifting strategy works
You can make a gift towards a child’s pension at any age. So this strategy even works for new born grandchildren.
In terms of how much can be gifted into your child’s or grandchild’s pension it will all depend on their earnings.
Clearly a young child or grandchild is not going to be working or earning so they will be limited to contributing a net payment of £2,880 per tax year.
For children that are earning you can contribute up to 100% of their gross earnings or £40,000 per tax year, whichever is lower. You will need to subtract pension contributions already being made by them and/or their employer.
As well as the tax savings, another great feature of this gifting strategy is the fact your children can’t access these gifts until they reach pension age which is currently 55, moving to 57.
Perfect if you are worried about the gift being wasted if you don’t quite feel your child is ready to receive to manage the money.
In fact, your child does still get an immediate benefit because of the way the Income Tax relief works. Their income will be increased.
In the example above, although Kelly doesn’t benefit from the actual gift until she reaches pension age, the impact of the gift has still increased her income by £2,000 per year by way of claiming higher rate tax relief. This figure could be higher if she makes the extra pension contribution via salary sacrifice through her employer as she will also save National Insurance.
There are two ways you could make a pension gift to your child. Either you contribute directly to their pension or they increase their pension contributions themselves via their employer and you cover the difference by via a payment to your child.
Please remember that you will still need to survive for 7 years for gifts into pensions over the £3,000 gifting allowance however there is insurance you could put in place to mitigate this.
If you would like to learn more about various Inheritance Tax saving strategies then please get in touch for a no obligation free 15-minute call where we can outline the savings that can be made.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.