Gifting money to children and grandchildren explained

Under HMRC rules, everyone is allowed to gift a certain amount of money within certain time frames without it being taxed. But above those thresholds and outside of those circumstances, gifts are taxed like estates to ensure people don’t use them to entirely evade inheritance tax.

In general, gifts to children and grandchild are tax-free if:

• You hand out less than £3,000 total in a tax year.
• The gifts are small (less than £250 per person).
• You give a certain amount of money on the occasion of a wedding.
• You gift the money more than seven years before you die.

Otherwise, money you directly give to anyone other than your spouse or a charity is subject to gift tax, which can be up to 40%.

Gift tax is levied by HMRC on financial gifts to people in circumstances that aren't tax-exempt. 

Gift tax is basically a form of inheritance tax. The gift tax rate can be up to 40% if you die less than three years after giving the money - the same rate as inheritance tax. But the exact tax rate depends on when you die, with the tax paid retrospectively after your death, under the rules about potentially exempt transfers.

You can gift money to your children and grandchildren without it being taxed in the following circumstances:

• Annual exemption: In each tax year, you can give a total of £3,000 to anyone you please without it being taxed. If you didn’t use your allowance in the previous tax year, you can pass on £6,000. However, the exemption can only be carried forward one tax year.
• Small gift exemption: You can make additional tax-free gifts of up to £250 per person, such as for birthdays or at Christmas, provided the recipients haven’t previously benefited from your annual exemption.
• Weddings or civil ceremonies: Each parent can give their child up to £5,000 to commemorate their marriage without it being taxed. Each grandparent can give up to £2,500.
• Regular payments from your taxed income: You can also give a child or grandchild money by regularly contributing to their living costs or expenses out of your taxed income. But for the child or grandchild not to pay tax on the gifts, the pattern of giving must be consistent - such as monthly gifts to pay a child’s rent or a grandparent paying school fees - not sporadic. Additionally, the money needs to be from your surplus income. You must be able to prove to HMRC that gifting the money doesn’t affect your standard of living. This is to ensure people don't hand money over to their children to avoid it being taxed.

Other gifts to children or grandchildren are potentially exempt transfers. If you die within seven years of handing over the money, it will be considered part of your estate and taxed accordingly. But if you live beyond that, the money won’t be taxed.

Potentially exempt transfers are money you hand over to people who aren’t your spouse or civil partner, and that may be subject to tax in the future, depending on when you die.

If you die more than seven years after gifting the money, it won’t be taxed. 

But if you die before then, the money will be considered part of your estate and taxed accordingly. But how much tax is levied depends on when the gift was made and when you die - a mechanism called taper relief.

If the gifts end up subject to taxation, the tax will be retrospectively collected from the recipients after your death.

The rules around potentially exempt transfers exist to prevent people from giving away their money just before their death, or upon receiving a terminal diagnosis, in order to evade inheritance tax.

But remember that estate inheritance is only levied on the part of your estate over £325,000. So your beneficiaries won’t have to pay tax on previous gifts, unless those gifts and your estate total more than £325,000.

Note that payouts from your life insurance to your family or others are usually considered part of your estate, unless you write your policy in trust.

There are some other workarounds to gift and inheritance tax:

• Contribute to a junior ISA: Junior ISAs are tax-free savings accounts for children under 18. Only a parent or guardian of the child can open the account, but anyone can pay into it tax-free, as long as the total contributions into the account don’t exceed £9,000 in a single tax year.
• Buy them Premium Bonds: You can also buy your child or grandchild Premium Bonds from the Treasury-backed NS&I. Premiums Bonds don’t pay interest, but give the holder the chance to win tax-free prizes of up to £1 million each month.
• Set up a trust: A trust can ring-fence money for a child or grandchild until they reach adulthood. However, there are complicated rules surrounding trusts and taxations that are outside of the scope of this article. If you want to explore setting up a trust for your descendants, you should speak to a financial advisor.