Here we use a case study to illustrate Inheritance Tax (IHT) considerations to optimise gifting children and grandchildren.
Marjorie and Patrick are both age 75, healthy and look forward to their Caribbean cruises in January, March and November each year, when travel is possible. They enjoy a nice cabin with a decent-sized balcony and premium economy flights, with each holiday costing around £7,000 for them both Due to Covid 19 , their cruises were cancelled in 2020 and they don’t yet feel comfortable to commit for this year either.
In their working lives, Marjorie was a nurse and Patrick a civil servant, and now both enjoy final salary defined benefit pensions that exceed their normal expenditure requirements.
With the holiday money now sitting in their savings account, earning very little interest, they’d like to do something with these funds to help their daughter, Amy, 50, and her two children Michael, 26, and Gayle, 23, as it’s been a difficult year for them all.
Amy has recently separated from her husband, and although she has a good job and has been working from home, she has found living on her own emotionally difficult over the last year whilst in and out of lockdowns. The eldest, Michael, was due to get married to his longer-term partner Martin in 2020, but this has now been rearranged until later in 2021 when they also plan to move into their new home. Gayle has been furloughed from her job in hospitality but is now pleased to be returning to full-time work.
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How to make Inheritance tax, tax-efficient
Marjorie and Patrick are both aware that there are Inheritance Tax (IHT) considerations and want to ensure that they don’t fall foul to these and make gifts in a tax-efficient manner to support their child and grandchildren. After taking advice, they’ve decided to make the following gifts.
Marjorie and Patrick will use the annual exemption, currently worth £3,000, meaning that this is the value of gifts which can be given away each tax year without being included in the value of the estate. As they didn’t use last year’s allowance, they understand they can carry this forward, making £6,000 available for each of them as an annual exemption, making £12,000 in total.
They will gift Michael, their grandson, £6,000 to help with the costs of getting on the property ladder -such as the mortgage deposit, moving costs and new furniture.
Of the £6,000 gift made to Gayle, their granddaughter, she is going to use £2,000 of this to help buy a car, which she needs in order to return to work. With the remaining £4,000, she will invest into a Lifetime ISA (LISA) as she is looking to build up funds to help purchase a flat in the next few years.
Using the LISA, Gayle can save up to £4,000 for the 2021/2022 tax year. The state will then add a 25% bonus on top. So, the grandparents’ gift of £4,000 will return a bonus of £1,000, meaning Gayle will have £5,000 before interest or growth to use towards her first home.
As Michael is hopefully getting married this year, Marjorie and Patrick would also like to make a gift of £2,500 to help towards the couple’s honeymoon, for when they are allowed to travel. For weddings and civil ceremonies, they can make gift £2,500 if it’s a gift to a grandchild’s wedding.
Normal expenditure out of income.
Finally, Marjorie and Patrick would like to help their daughter Amy out, too. She has a good job, earning £70,000 per annum. They know she has always been keen to save towards her later life but, unlike her parents, hasn’t enjoyed the privilege of membership of a defined benefit pension scheme. Instead, Amy is a member of her employer’s defined contribution workplace pension scheme, where she matches her employer’s contribution of 5%. Marjorie and Patrick feel that they can afford £500 per month, and even if they return to three cruises a year, this won’t affect their standard of living.
Marjorie and Patrick elect to do this using the IHT gifting from normal expenditure out of income. This is one of the lesser-known ways of reducing the value of an estate, but it can be one of the most effective. It has to be regular, taken from income not capital, and it cannot reduce the standard of living of the person giving the gift – so ideal for pension contributions.
This will provide a pension contribution of £500 per month and, although a third-party gift, it is treated as if the recipient, Amy, had made the contribution herself.
Annual Pension Calculations for Amy:
£500 x 12 = £6,000
Plus tax relief (20%) of £1,500
Total Pension contribution of £7,500
Amy, as a higher-rate taxpayer, can also claim back a further 20% (£1,500), making the net gain to her of £9,000. Giving a further boost to her objective of saving for later life, in addition, the £7,000 employer and employee contribution makes the total pension contribution in the year £14,500.
Marjorie and Patrick, although missing out on their holidays, are both delighted to have been able to support their family during these difficult times and watch them enjoy and grow into their new lives looking forward to what will hopefully be a new and exciting future around the corner.
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