Inheritance tax – Britons could save thousands by ‘avoiding common tax traps’

As the cost of living continues to bite, parents and grandparents may be more inclined to gift to their children, however many are warned not to fall into “common inheritance tax traps”.

Over one-third of retired people said they have given, or plan to give, gifts of £5,000 or more, according to research by Hargreaves Lansdowne.

This is likely to include those who are now keen to use them to help their family and not pay more inheritance tax (IHT) than they need to.

Just under half of parents with children in the household have given gifts of more than £5,000, or plan to do so.

Parents seeing the rising cost of living making things tougher for their children may even feel willing to gift more.

If someone is thinking about passing on some of their wealth, experts at Hargreaves Lansdowne have explained there are seven ways they can do it to “avoid tax traps and gifting glitches”.

1. Use a Junior ISA

As Britons don’t pay inheritance tax on any gifts they give five years, it could be useful to gift to children under 18.

In the 2023/24 tax year, you can add up to £9,000 into a Junior ISA for a child, which can be saved or invested tax efficiently. 

2. Consider a Lifetime ISA

Once children reach 18, it’s possible to super-charge that gift by putting up to £4,000 a year into a Lifetime ISA – within their overall £20,000 annual ISA allowance. Lifetime ISAs are available for people aged 18-39 and contributions can be made up to age 50. This will be boosted by the 25 percent government bonus, adding £1,000 for every £4,000.

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3. Consider insurance for potentially exempt transfers

If people give larger gifts, and they don’t live for at least another seven years, they can fall back into their estate for IHT purposes.

Britons can consider a life insurance policy to cover their entire potential tax liability, including these gifts. This should be written in trust, so it falls outside of one’s estate, and there’s no IHT to pay on it.

Taking advantage of the rules around gifting could significantly reduce a person’s inheritance tax bill, as this enables them to transfer wealth outside of their taxable estate.

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Gifted transfers exempt from a person’s estate and are therefore ignored by IHT, include:

• The £250 small gift allowance – gift £250 to as many people as you want, as long as another gift allowance has not been used on the same person
• The annual exemption – gift a total of £3,000 a year to either one person or split between several people
• Gifting from normal income – all gifts from regular salary are exempt from IHT.

4. Practice philanthropy

Gifting or leaving money in a will for charities, political parties, the national purpose and housing associations will always be free from inheritance tax.

5. Spoil a spouse

If a spouse dies and their tax-free allowance of £325,000 has not been used up from gifts to others in their will, then their remaining tax-free allowance can be transferred to the surviving spouse; potentially doubling their allowance so they can pass on up to £650,000 tax-free when they die.

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