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Knowing when and how to pass your wealth on to the next generation can be a challenging financial conundrum.
The record amounts of inheritance tax (IHT) that families are paying is focusing attention on how to pass money on tax-efficiently.
While seeing them benefit can be very rewarding and help to reduce a future IHT bill, there are also risks to consider. We’ll explain the pros, cons and best ways to pass on money.
What’s on this page?
Firstly, there’s the satisfaction of seeing your children (or other beneficiaries) enjoy and benefit from a financial gift. Secondly, there’s the fact that more families are paying inheritance tax, and are paying larger amounts. And this rise is due to continue.
A combination of frozen thresholds until April 2030, plus pensions, farm and business property coming into the scope of IHT, means that the Office for Budget Responsibility forecasts that IHT tax receipts will increase to £13.3 billion a year in 2028/29, and £14.4 billion in 2029/30, up from £7.1 billion in 2022/23.
Giving money away while you’re still alive can be an effective way to reduce a future IHT bill if your estate is likely to exceed the thresholds. As well as specific exemptions and allowances, if you live for seven years after making the gift, most things will be considered outside your estate for IHT purposes.
But deciding when – and how much – to give isn’t easy. “It’s a very personal decision that can come down to your priorities but also family dynamics,” says Amy Grace, director and chartered financial planner at Five Wealth.
“As there are so many things to consider, it’s worth getting professional advice.”
Alongside objective guidance on what can become a highly emotional topic, a financial adviser or solicitor can also ensure the right paperwork is in place.
This might include a will or documentation to support a gifting strategy, or just explain the tax ramifications of any decisions you make.
However much you might want to reduce the IHT your loved ones pay through passing on your wealth now, Grace says it’s crucial to consider your own needs first.
“You want to be able to maintain your standard of living and factor in any unexpected [future] costs such as a care home or home improvements,” she explains.
“Cash flow modelling, where a financial adviser works out future expenditure, can help you see how much money you need and whether there’s any surplus that you could consider passing on.”
Giving away too much, too soon, could also make things difficult if you do need to pay care home fees one day.
If your local authority thinks you’ve given away money to avoid paying for care (referred to as deprivation of assets) then your fees would be calculated as if you still had that money.
This could, potentially, leave you in the awkward position of asking your kids to pay the money back – or the local authority could try to recover the money themselves.
Even if you can afford to give money away to reduce an IHT bill, there are still other risks to consider.
“A large cash gift to young adult children could be frittered away by short-term financial decisions or it could decrease their desire to build wealth of their own,” says Emma Geale, solicitor in the private client team at Mills & Reeve.
Older children may be a bit more savvy with money but there are still potential pitfalls, especially if a marriage ends or they get into financial difficulty.
“An advance on an inheritance could become part of the child’s ‘matrimonial’ assets to be divided on divorce,” adds Geale. This would mean any of your money you intended to help your child in the future could end up partly in the hands of an ex.
Or, in the event of a child being declared bankrupt, this inheritance could be used to pay off creditors. If you’re worried about this happening, talking to a qualified professional may help you understand any protections that can be put in place to prevent this from happening.
Passing on property while you’re still around can sometimes be more problematic than just giving money.
“Trying to reduce IHT by gifting the family home can be more hassle than it’s worth,” says Geale. “In some cases, it might even lead to more tax being paid overall.”
If you give your home away and continue living there, it’s considered a gift with reservation of benefit.
This fancy legal term simply means you haven’t really given it away, it remains in your estate when IHT is calculated and the person receiving the property would usually have to pay the tax.
To lose the reservation of benefit tag, you would need to pay a fair market rent to your kids to continue living in the property.
“This can be expensive,” adds Geale. “Plus, this rent is taxed as income in the hands of the children, which could be at a rate of 40% or 45% if they’re higher or additional-rate taxpayers.”
Even if you do pay market rent, you could still find yourself homeless. Phil Clayton, director in the private client tax team at PKF Littlejohn, explains that much like with gifting, the house could become part of a financial solution.
“Should they go through a divorce, or bankruptcy, you could find yourself evicted by your own children if they have to use the house’s value for their own circumstances,” he says.
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However much you want to pass on, it’s worth taking advantage of the IHT allowances and exemptions. “You can give up to £3,000 away each year with your annual gift allowance,” says Sarah Coles, head of personal finance at Hargreaves Lansdown. This is also known as your ‘annual exemption’.
“You can also give away surplus income IHT-free, providing you make regular payments and you can afford them after meeting your usual living costs.”
However, it may need to be proven after you’ve passed away that this was truly excess income and giving it away didn’t impact your standard of living.
Extra income could be paid regularly into a Junior ISA or even a pension for a child or grandchild.
They wouldn’t be able to access it until they were older (18 for a Junior ISA or, from 2028, 57 for a pension), which could address concerns about it being spent responsibly, and they’d also benefit from the tax advantages of these saving vehicles.
There are other exemptions that you can consider, such as for weddings or small gifts, but whichever you pick, Coles has the following advice: “Keep good records of any gifts you make,” she says. “This will really help when your loved ones are sorting out your estate.”
If you’re not comfortable giving money outright, you could consider placing a gift in trust.
This might be the case if you don’t feel someone is ready to handle an early inheritance or their marriage or business is a little rocky.
Depending on the arrangement, this could give you more control over who gets the money and when.
But if you do want to explore this route, expert advice is essential as creating trusts can be highly complex.
Geale explains: “The current IHT regime has made [trusts] less popular than they once were, but we do still see them being used to make gifts to children in a will as they provide asset protection and flexibility.”
You also need to be aware of the tax implications, as there may be initial and ongoing tax charges depending on how much you put into trust.
Whether you pass on an inheritance now or leave it in your will, you’ll want to know your kids and grandkids are ready for it. “Lots of people will consider passing their knowledge on at the same time as their assets,” says Coles.
“It can be an opportunity to teach their children or grandchildren about money. It’s much easier to get to grips with financial issues if they have some skin in the game.”
As an example, setting up a Junior ISA or a pension with them could help them understand more about investing, regular savings and tax breaks.
This knowledge transfer is even more important when passing on an asset such as the family business or rental properties.
Getting them involved will help them learn the ropes - but do be prepared for the possibility that they might want to take the business in a completely different direction.
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