Gifting to the next generation is an increasingly popular way of passing on wealth, and after the inheritance tax (IHT) allowance freezes and the incorporation of pensions into estates (starting April 2027), it’s a tax-efficient way too.
These past reforms could be compounded by those rumoured to be announced in next month’s Budget: rumours that the current 25% tax-free lump-sum allowance might be cut, that the £3,000 gifting allowance might be cut and that the seven-year wait time for gifts to escape IHT might be extended to 10 years.
This has triggered a flurry of activity among pension savers, who, rather than waiting and letting IHT take its share, are choosing to pass on their wealth sooner rather than later. And it is a sensible choice too. As James Corcoran, senior chartered financial adviser at Lumin Wealth, said: “The children will inherit anyway”.
By gifting some of the inheritance early, taxes reduce and “you get to see your children enjoy the money”, whether that means paying off a mortgage, buying a better home or funding their children’s education.
A prominent example of someone gifting early is James Henderson, portfolio manager of the Lowland and Law Debenture investment trusts, who said: “It makes sense for me now to gift shares in the two investment trusts I manage to my two children, who are in their 20s and 30s. I have a lot of faith in the strategies we’re using to manage these trusts. UK equities are cheap and we're finding value across the market cap spectrum.
“I have encouraged them to remain invested because I think they’ll be handsomely rewarded for doing so. Of course, I am passing on a different tax problem – capital gains tax, – but that’s for them and their financial advisers to tackle.”
Other pension savers might want to gift cash instead of shares and this has been highlighted as a way to reinvest money taken (perhaps hastily) from pensions as a tax-free lump sum. Corcoran explained that by gifting this money to children, the funds go back outside the estate and can grow tax-free, for example in a Stocks and Shares ISA.
However, there’s downsides to consider too. One could be the psychological impact – could the gift create imbalance, make the children dependent or less driven to work?
Some parents make gifting conditional on their children seeking advice, because otherwise the funds could end up sitting idle or in high-risk assets such as crypto, the financial planner noted.
There’s also long-term care to account for. “If you give too much away and later need care, you might have limited options. Or if the children divorce, that money could leave the family.” To avoid the latter problem, that’s where trusts come in: they allow parents to retain control and decide who benefits and when.
Gifting rules and allowances
The popularity of gifting has been accelerated by rumours that the gifting allowance might be cut in next month’s Budget.
As of today, each year Britons can gift £3,000 tax-free. Henderson said: “I hope the chancellor does not try to limit the level of gifting, because it will make for horrendous complexity”.
However this allowance is often misunderstood, according to Corcoran. For starters, anyone can use it – meaning both parents can give £3,000 each to their children every year. On top of that, there are separate allowances for weddings or individual gifts: £250 per person, £5,000 for a child’s wedding and £2,500 for a grandchild’s. Those don’t count as potentially exempt transfers.
Then there’s the ‘gift-from-income’ rule, which people often forget. As an example, if your income is £100,000 and you regularly spend £30,000 a year, you can gift all of the remaining £70,000 with no problem, as long as it’s from surplus income and not capital.
“People get caught up thinking they can only gift £3,000 a year. That’s not right – you can gift whatever you want. There’s no tax on the giver or the recipient,” Corcoran said.
One factor that has discouraged people from gifting is the so-called ‘seven-year clock’, under which gifts escape IHT if the giver lives on for seven years afterwards. For Corcoran, however, this isn’t reason enough to be put off.
“Even if you don’t survive the seven years, the funds are still growing in the children’s names [provided they are invested]. If your gifted £100,000 has grown to £110,000 and you don’t beat the seven-year clock, £100,000 goes back into the estate for IHT purposes, but the £10,000 growth is outside,” he explained. “Even if you don’t expect to live seven years, gifting is still worth it, if you’re happy to.”
When insurance makes more sense than an ISA
Another option Corcoran said many of his clients are now taking is whole-of-life insurance. For those who face an inheritance tax bill but can’t or won’t gift – especially if most of their wealth is tied up in property – a whole-of-life policy can be highly effective.
The big catch-22 with inheritance is that children cannot access their parents’ money until they pay the IHT bill, but they can’t pay IHT until probate has been granted. To avoid being caught in this loop, they need enough money immediately after death to unlock the inheritance – which is exactly what a whole-of-life policy provides.
“Probate takes time, selling property takes time and families are often grieving and unprepared. Having a whole-of-life policy provides an immediate lump sum to pay the tax,” said Corcoran.
The money for this insurance can be redirected for example from an ISA.
Pension savers paying £20,000 a year into ISAs may only create a portfolio that will itself attract IHT in future, but if the same £20,000 were used to fund a whole-of-life policy, depending on age and health, it could generate around £1m of cover, Corcoran explained.
“It’s not an investment – it’s protection,” Corcoran said. “But for families with high property values, it can be extremely beneficial. Once a property exceeds £1m, you’re in inheritance tax territory; above £2m, you lose the residence nil-rate band. For those people, a whole-of-life policy can be a very effective solution.”