Lilly Whale: Tax planning for grandparents explained

With the widening chasm between the older generation living longer and the younger generation finding it harder than ever to fund big life events, it is little wonder that grandparents often skip their Generation X children in favour of passing their wealth to their Generation Y/Z grandchildren.

Nowadays Gen-X simply cannot always help with university fees or the deposit for a first home, whereas grandparents often can.

Despite the shift in modern-day money habits, the law on gifting – at least from an inheritance tax perspective – has unfortunately remained steadfastly limited. That being said, a healthy mix of forethought and creativity can ensure that wealth is passed down without incurring colossal inheritance tax (IHT) bills both during lifetime and on death.

My gift to you

The tried-and-tested route for many grandparents is simply to gift money during their lifetime; provided they survive such gifts by seven years the value falls out of their estate. Otherwise, the gifts become chargeable and will use up all or part of their nil rate band (£325,000).

Say, for example, that on 1 May 2021 Mrs Jones made two gifts of £162,500 to each of her twin grandsons on their turning 16. She sadly died on 1 June that year. Mrs Jones had already gifted £3,000 that year to her godson such that her £3,000 annual exemption of gifts from capital had been exhausted; accordingly, the two gifts came back into her estate and wiped out her available nil rate band. Her entire estate was consequentially taxed at 40% and could not benefit from the £325,000 tax-free threshold.

Say instead that Mrs Jones made the same gift on 1 May 2014 and survived. By 1 May 2021, the seven years elapsed and the £325,000 dropped out of her estate with no IHT consequences. She would be free once more to gift any sum of money and trigger a fresh seven-year period.

Provided the donor can afford it, making gifts as early as possible should help to reduce the risk of the gift entering back into the estate if they fail to survive for seven years. 

Clearly, however, in either scenario, the twins are very young and one may feel understandably hesitant about gifting such large amounts of money on the off chance the funds are not looked after.

At your discretion

One alternative could be for Mrs Jones to settle the funds into a discretionary trust so that access is controlled by one or more trustees (e.g. the twins’ parents) who could advance capital to her grandsons as and when they felt appropriate.

Discretionary trusts do come with their own rules and charges; where a transfer into trust made in a rolling seven-year period exceeds the nil rate band, an entry IHT charge applies at 20% on the excess over the available nil rate band. Clearly, that would not apply here if Mrs Jones settled £325,000 into trust but would if the initial payment was any greater in value. In addition, charges are levied during the trust’s existence at every ten-year anniversary and also when assets are distributed to the beneficiaries. Any grandparent considering this route would be well-advised to speak to their financial adviser to ensure that a discretionary trust is a viable option.

Grandparents should also be aware that gifting into a discretionary trust is considered a disposal for capital gains tax (CGT) purposes. This would not apply to Mrs Jones if she gifted cash as there is no gain; if, however, she were putting property into trust then there could be a CGT liability if the property’s value had increased since she first acquired it. Again, a financial adviser can help to examine these nuances.

Grandparents can carry out exercises on IHT planning on a far smaller scale too, and there are other ways (albeit perhaps less impactful) of passing on their wealth without triggering IHT liabilities For instance:

  • Grandparents wanting to cover the cost of music or driving lessons can gift up to £250 to a single recipient tax-free – although note that the recipient cannot have benefitted from the £3,000 annual exemption.
  • Grandparents may assist with paying pocket money by gifting cash out of their surplus income. Provided they can demonstrate (if asked by HMRC) that the gifts are regular (monthly, quarterly etc.) and in no way have a detrimental impact on their standard of living, there will be no IHT charge.
  • For anyone whose grandchild is getting married, grandparents can gift up to £2,500 tax-free as a wedding gift to the happy couple.

Clearly, an overarching concern any grandparent might have before making gifts is how old their grandchildren are and, keeping in mind their financial competence, whether it would be wise to hand over large amounts of cash. Careful planning should ensure that gifts are not frittered away too young or do not create a bigger IHT liability down the line.

Lilly Whale is an associate in the private client team at law firm Goodman Derrick