The taxman is after your grandchildren’s inheritance – here’s how to stop him

The “bank of grandma and grandad” plays an increasingly important role in helping younger generations.

Millennials and Generation Z are expected to be in a far worse position than their parents and grandparents by the time they reach retirement age. 

Decades of house price growth have frozen first-time buyers out of the property market, while millions of young workers face an uncomfortable retirement, thanks to private pensions being nowhere near as generous as their parents’ and grandparents’ gold-plated defined benefit pensions.

Passing down wealth can make a huge difference to your grandchildren’s lives. However, whether your goal is to help a grandchild get on the housing ladder, cover day-to-day living costs or build up their retirement savings, serious consideration needs to be given to how you do it – otherwise you could risk throwing away thousands of pounds in tax. 

Get your head around inheritance tax 

Before you do anything, make sure you understand the rules around inheritance tax (IHT). If your estate is worth more than £325,000 when you pass away, then IHT could be charged at 40pc on values over the threshold, leaving your family with a potentially massive tax bill. 

If it looks like you could be caught in the IHT trap, then giving wealth during your lifetime is one way to reduce the size of the bill your family will have to pay.

However, there are rules on how much you can gift. Every individual can give away £3,000 a year IHT-free. You can also give £2,500 to a grandchild in the year of their wedding (this rises to £5,000 if you’re a parent and your child is getting married). 

Larger gifts will only become IHT-free if you survive them by seven years. There are different rules for trusts, which we delve into below. 

Five ways to pass on your wealth

Use your pension

One highly tax-efficient way to pass on wealth is to take an income out of your pension, or leave it to your grandchildren after you pass away. 

How to do it

First, open a personal pension. You can deposit up to £60,000 into a pension each year tax-free. There is no limit on how much you can save up over your lifetime now that the Lifetime Allowance has been scrapped. 

Example

If you would prefer to help out your grandchildren during your lifetime, you could gift money straight from your pension. Once over 55 (rising to 57 in 2028), you can access your pension savings and withdraw 25pc as a tax-free lump sum. Any other withdrawal from your pension will be liable to income tax at your marginal rate. 

However, if you have no income other than your pension, you can withdraw up to the personal allowance of £12,570 every year free of tax. 

If the grandchild receiving the sum is not earning, then 0pc tax will be due. However, there could be an IHT liability, so check that your plan does not fall foul of gifting rules. 

Alternatively, you could choose to gift your pension on death. This can be inherited by your grandchild, or whoever you choose on your expression of wishes form, free from IHT. 

However, they will still pay income tax if you die after the age of 75 at their rate of income tax. If you die before 75, no income tax is payable.

Pay into your grandchild’s pension

Your grandchild’s retirement may feel a long way off, but saving into a pension that they can then access in later life can be a very tax-efficient way to invest.

How to do it

Only a parent or guardian can set up a Junior Self Invested Personal Pension (Sipp) for their child. However, anyone can contribute to it at any point after the child has been born. 

You can put away up to £3,600 a year. The Government will pay tax relief at the basic rate of 20pc, so ultimately the cost to the grandparent is £2,880 a year. 

Steven Cameron of pensions firm Aegon said this will be included in the annual gift exemption of £3,000, or may be paid as a gift out of surplus income, “which would be helpful if a grandparent wanted to pay into the pension of more than one grandchild.” 

Example

If £3,600 was paid into the child’s Sipp every year from birth, then by age 18 the fund would be worth £98,500, according to Aegon’s calculations. That is assuming the investment growth after charges is 4.25pc per year. Even after inflation of 2pc, this would be worth £69,000. 

“If left invested until age 67 this would grow further to £757,000, or to £200,000 in today’s money terms, allowing for 2pc inflation,” Mr Cameron said. 

“The contributions paid in those early years have the longest time to grow, maximising the magic of compound investment growth.”

Use Individual Savings Accounts (Isas)  

If you want the child to be able to access the funds sooner, a Junior Isa may be a better option; a Junior Stocks and Shares Isa gives the sum the chance to grow over time. The child will take ownership of the account when they turn 18, at which point it will convert into an adult Isa.

How to do it: 

As with a Junior Sipp, only parents or guardians can set up the account, but anyone can add money. Up to £9,000 can be contributed each year, and all growth will remain free of tax. 

If your grandchild is over 18 and you want to help them buy their first home, one tax-efficient option is to save into a Lifetime Isa (Lisa) – they’ll need to open this themselves. You can only save up to £4,000 a year, however the Government will top up by 25pc, provided the money is used to purchase an eligible property worth up to £450,000. 

Example: 

Here we explain how to build a pot worth £1m by contributing £9,000 a year into a child’s Jisa.  

Use trusts 

Trusts can be a great way to pass down wealth tax efficiently, however they can be relatively complicated. There are generally two types that grandparents can set up: bare trusts and discretionary trusts. 

A bare trust, the simplest option, is where the grandparents effectively hold the assets as nominees for their grandchildren. Despite this, any income or gains generated will be taxable on the grandchildren, and therefore should benefit from their tax allowances and bands.

However, the grandchild will have the legal right to call for all of the assets once they reach the age of 18 (or 16 in Scotland). 

Grandparents who want to keep control of the funds for longer – for example, to put towards a grandchild’s house purchase – may want to consider setting up a discretionary trust instead. With this kind of trust, there is no automatic entitlement for the grandchild to request the assets when they turn 18. 

How to do it

You should use a solicitor and financial adviser to set up a trust. It is worth taking extra time to ensure the professional is qualified to set up a trust – because any mistakes can be costly. The Law Society has a searchable database where you can find a solicitor for the task. 

Example

There is no limit on how much can be transferred into a bare trust. However, you need to consider the IHT consequences.

Anthony Whatling of financial advice firm Evelyn said: “Setting up a bare trust would be a Potentially Exempt Transfer for inheritance tax purposes, meaning that the amount settled will fall outside of the grandparents IHT estate provided that they survive for seven years.”

By comparison, the transfer of assets into a discretionary trust will give rise to an immediate IHT charge of 20pc if you transfer more than your available nil-rate band. 

“This means that, for most couples, the most they could transfer into a trust would be £650,000,” Mr Whatling said. 

You also need to think about capital gains tax, which will be due on the investment returns within the trust. Mr Whatling said: “The trustees pay at the highest rates of tax, but generally the grandchildren should be able to claim some or all of that tax back when they receive a distribution from the trust, assuming that they are lower-rate taxpayers.”

The gift into the trust may also trigger a CGT liability, unless it is a transfer of cash. “For a discretionary trust it is possible to “hold over” the gain so that the CGT liability is effectively deferred until the trustees sell the asset,” Mr Whatling said. 

Mr Whatling added that using trusts to make provisions for grandchildren is more tax-efficient than if you are gifting to your own children under the age of 18. 

“There are rules in place that mean that where parents set up a trust for their own children, and the total income is more than £100, all the income is taxed on the parents directly.”

Gift property 

Gifting your main home property to your grandchildren, they will benefit from the £175,000 residence nil-rate band from you die. 

However, there could be an additional IHT bill to pay if your estate as a whole is over the threshold of £500,000 (including the nil-rate band) – or £1m for a couple. 

If you give away your property while you are alive, then you would need to live seven years after the handover for it to move outside your estate for IHT purposes. However this only matters if you give away more than £325,000 in the seven years before you die. 

If you continue to live in your property after gifting it, then you must pay market rent to your grandchildren, or the taxman may include it as part of your estate for IHT purposes. 

Over the past five years, the taxman has clawed back more than £600m from almost 2,000 families who were found to be in breach of so-called “gift with reservation of benefit” rules.  

If there is a mortgage then your child will have to pay stamp duty. 

How to do it

Make a deed of gift to legally add a person to your property deeds. 

Example: 

A family could save £240,000 in IHT by moving a £600,000 second home into a trust, according to Evelyn’s calculations.