- There are legitimate ways to pass down money without incurring tax
- Unexpected tax bills could crop up if you don’t follow the rules
As inheritance tax receipts hit a record £7.1billion a year, a growing number of families are looking for ways to slash their costs.
From making gifts during your lifetime to setting up trusts, there are many legitimate ways to pass down money to loved ones without incurring tax. But before you steamroll ahead it is worth doing your homework.
Fail to abide by the strict rules and you could inadvertently land your family with an unexpected tax bill.
We have identified eight major pitfalls that you should be wary of when planning the future of your estate, and how much they could cost you.
1 Hand over home and stay in annexe – £115,000 hit
Parents often want to pass on the family home to their children – but without landing them with a massive tax bill.
A property worth up to £1million can be handed by a couple to direct descendants tax-free – but anything above this is charged at 40 per cent.
A single person with children can pass on a home worth half that sum tax free. Therefore it can be tempting for parents to hand over a family home during their lifetime, in the hope that it won’t form part of their estate for inheritance tax purposes.
There is no inheritance tax to pay on gifts so long as you live for a further seven years after making them. However, this plan can easily backfire if done incorrectly. That is because if you continue to live in the home after gifting it, it is considered a ‘gift with reservation of benefit’.
That means that the property is not deemed a genuine gift because it comes with strings attached.
Should this happen, the property may still be considered part of your estate when you die and therefore could attract inheritance tax.
Ian Dyall, estate planning specialist at wealth manager Evelyn Partners, says: ‘Generally, gifts will only be effective in mitigating inheritance tax if there is no continued use of the gifted assets and no strings attached, saying that they can be returned to the donor.’
The impact of this will depend on what the property is worth and what other assets you have. If, for example, you gifted your child a second home, but still used it regularly for holidays, your family could be hit with a bill of about £115,000.
This assumes that you own your own home and that it is worth more than £325,000 – or £650,000 if you’re a couple – and have a second home worth the average UK house price of £288,000. To mitigate the risk, you could pay your child rent if you plan to continue using the property.
But be careful: you must pay rent at the going market rate for it to be valid. And your children would have to pay income tax on the rent you paid them.
HOW THIS IS MONEY CAN HELP
2. Sell up and buy home together – £27,000 hit
Don’t think you can get around the rules by selling your home and gifting your children the cash to buy another one.
Dyall says he often sees cases where parents sell their home so their child can buy a bigger property for them to all live in together.
However, because the children then allow the parents to live rent-free, they risk a shock tax bill. ‘In some cases it is done completely innocently,’ he says, ‘perhaps by families buying a new home together so the grown-up children can provide care for an infirm parent.’
Families who do this risk falling foul of either ‘reservation of benefit’ rules, which would lead to an inheritance tax bill, or so-called ‘pre-owned asset’ legislation, which would lead to an income tax bill.
The latter would mean you could be landed with an income tax bill based on the rental value of the property. For example, if you sold your home and handed the cash to your child to buy a home for you all to live in together, Revenue & Customs would work out what share of the property came from your gift, add the annual rental value of that share to your income and charge you income tax on it.
It is effectively billing you for the benefit it deems you to have received. On the average UK rent of £1,126 a month, according to Zoopla, this would amount to a tax charge of £2,702 a year (or more for higher rate taxpayers). Over a ten-year period, that amounts to £27,024.
3. Make half-hearted gifts – £3,500 hit
If you make a gift, ensure you do it properly and formally. For example, if you hand over a painting, do so physically – even if it means leaving an unsightly space on your wall.
You should also make sure the beneficiary adds it to their home insurance – and you take it off yours – so there is evidence that the gift has been made.
Mike Warburton, a former tax director at the accountancy firm Grant Thornton, says: ‘There is a temptation, for example, to say after your parents have died that their valuable Old Master had been given to you seven years ago.
‘Contrary to some rumours, tax inspectors are not stupid. Apart from the insurance issue, when the solicitor handling the estate calls round, what is your answer for the suspiciously clean patch on the wall where it used to hang?’
Revenue & Customs will often investigate if gifts were made seven years before the giver died. It has access to huge amounts of personal information via a database called Connect, says Robert Levy, a specialist in tax investigations at law firm Kuits Solicitors.
There is no time limit on how long the taxman has to open an investigation into this. The interest charged on unpaid inheritance tax is currently 7.75 per cent.
A penalty can then be added to this, depending on the reason for underpayment. Where a mistake has been made, or there was lack of reasonable care, families could pay up to 30 per cent of the extra tax due. So if you had a painting worth £5,000, and failed to pay inheritance tax on it, after five years you would owe £905 in interest, £2,000 in the initial unpaid inheritance tax and £600 as a late penalty – amounting to £3,505.
4. Fail to put life cover into trust – £45,000 hit
Life insurance policies are often taken out to pay out to loved ones on the policyholder’s death.
But failing to set up the policy properly could needlessly land them with an inheritance tax bill. Life insurance policies can be put into trust, which means they are not included as part of your estate for inheritance tax purposes.
However, nearly 7,000 estates paid inheritance tax on life insurance payouts in 2020-21, according to the latest data.
These life insurance policies were worth £830million, which means up to £332million of inheritance tax may have been paid unnecessarily.
Sean McCann of wealth manager NFU Mutual says if a policy is not put into trust, it will be included in your estate. This means that up to 40 per cent of the payout could be lost to the taxman from the outset. On a policy that pays out £100,000, this would amount to a £40,000 bill.
‘Putting life insurance policies into trust is straightforward and many providers make trust forms available free of charge,’ he says.
5. Put pension cash into savings – £10,000 risk
Pensions can be a very tax efficient way of passing on money to loved ones. They can be passed on tax-free if the giver dies before the age of 75.
If they are older, the beneficiary pays income tax when they subsequently withdraw money from the pension.
However, pension holders often unwittingly jeopardise their tax-free status by needlessly withdrawing money from it and putting it into a savings account instead.
Once money is out of the pension, it is no longer safe from inheritance tax. This is a problem because pension holders frequently take advantage of their right to withdraw a 25 per cent tax-free lump sum from their pension whether or not they need the money.
McCann says: ‘Many people take significant sums from personal pensions, often with no clear idea of what they intend to do with the money, with many choosing to put it straight into a savings account.
‘It’s important to remember that money remaining in your pension on your death is normally free from inheritance tax, whereas savings accounts and most other investments are included when calculating an inheritance tax bill.’
For example, if you took £25,000 from a £100,000 pension pot and put it into a savings account, your beneficiaries would face a £10,000 bill when they inherited it. Whereas if you had left it in a pension, they may not have had to pay a penny.
6. Miss joint allowance – £200,000 hit
Couples who are married or in a civil partnership can combine their inheritance tax allowances.
A single person has an allowance of £325,000, but a couple has one of £650,000 to be used on the death of the remaining spouse.
However, many people do not realise that widows or widowers retain their deceased spouse’s inheritance tax allowance even if they remarry.
If you remarry, you can combine your inheritance tax allowance with that of your new spouse.
McCann says: ‘Many people who have been widowed and have remarried don’t realise they can potentially leave up to £1.5million free of inheritance tax. If their spouse was also widowed, they could leave up to £2million.
‘It’s important for anyone who has lost a spouse and remarried to take advice to maximise the sum they can leave tax-free to their family.’
For example, a widower who plans to leave the family home to his children could pass on a property worth £1million tax-free.
His new bride would also have her own allowance worth £500,000, assuming she too wishes to pass on a family home. Together, they can pass on a tax-free estate worth up to £1.5million.
7. Fail to tie the knot – £70,000 hit
You may have been with your partner for decades, have a home together, children, and shared finances.
But you will only enjoy the inheritance tax benefits of a couple if you are married or in a civil partnership.
If you own a property with your partner as joint tenants, your partner’s share will pass to you automatically if they die first.
However, their share still forms part of their estate for inheritance tax purposes so you may face a tax bill. If the property is worth £1million, their share would be £500,000 and so inheritance tax would be payable at 40 per cent on the sum above their tax-free allowance of £325,000. That would amount to a hit of £70,000.
8. Unclaimed overpaid IHT – £40,000 HIT
Inheritance tax usually has to be paid within six months of a death and is based on an estimate of the value of deceased’s assets on the day they died.
If the executors sell a house within four years of the death at a lower value they can reclaim the overpaid IHT.
Refunds are particularly common when house prices are falling, as the price achieved on a property is more likely to be less than had been expected. You can also claim back on shares and other qualifying investments that are sold at a lower value within 12 months of the death.
More than 5,000 families claimed a refund in the 2022-23 tax year after overpaying, official data shows.
That is up 22 per cent on the previous year.
McCann says: ‘Let’s take the example of someone who dies leaving significant assets, including a house worth £1million. Eighteen months after their death, the executors sell the property for £900,000. They could reclaim the inheritance tax on the £100,000 fall in the house price, resulting in a £40,000 reclaim for the beneficiaries.’
Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.
- Home affordability has improved according to the Office for National Statistics
- But average house still costs the equivalent of 8.4 years of household income
Home affordability has improved but homebuyers are still having to spend the equivalent of more than eight times their annual disposable income, official figures have revealed.
The Office for National Statistics said the average house price in the UK was £275,000 in the financial year ending 2022, while the average annual disposable household income was £33,000.
It means that the average house costs the equivalent of 8.4 years of household income.
The average house price to income ratios are lower in three of the individual nations, at 6.4 in Wales, 5.3 in Scotland and 5.1 in Northern Ireland.
The figure for the UK as a whole is a slight decline from the previous financial year when the ratio stood at 8.7.
However, the more recent ratio of 8.4 remains high and is out of reach for many homebuyers.
The ONS explained that on average, homes in all four countries of the UK have sold for more than five years’ worth of average household income since 2017.
It uses a threshold of five years of income as a broad indicator of affordability.
It went on to say that in England, only households in the top 10 per cent of income can afford an average home with fewer than five years of earnings.
It compares to the top 30 per cent in Wales and the top 40 per cent in Scotland and Northern Ireland.
The ONS does not take into account any effects on housing cost affordability resulting from changes to mortgage interest rates and payments.
It also pointed out that the pandemic affected income estimates in 2021 and created uncertainty in data collection.
And it pointed to volatility in 2021 and 2022 reflecting house price movements around changes in stamp duty.
Housing affordability ratios generally worsened from the start of the series in 1999, up to 2007 and 2008 in all four countries.
Following the 2008 financial crisis and up to around 2013, affordability ratios improved substantially in Northern Ireland and modestly in the other three countries.
From 2013 to 2019, affordability ratios in each country were either broadly stable, or worsened slightly. Since 2019, trends have been different in all four countries.
Ratios in each country
In the financial year ending March 31 2022, estimates of the median household income and median house price for each country were:
• In England, £275,000 for an average-price home and £33,000 for average income (a ratio of 8.4)
• In Wales, £185,000 for an average-price home and £29,000 for average income (a ratio of 6.4)
• In Scotland, £170,000 for an average-price home and £32,200 for average income (a ratio of 5.3)
• In Northern Ireland, £151,000 for an average-price home and £29,600 for average income (a ratio of 5.1)
Karen Noye, mortgage expert at wealth manager Quilter, said: ‘This situation will now be even worse as these calculations do not take into account any effects on housing cost affordability resulting from changes to mortgage interest rates and payments stretching people’s budgets that much further leaving with even less to save towards a deposit to buy a property.
‘The impact of this huge affordability pressure has already starting to be seen as people are forced to take out marathon mortgages just to be able to afford monthly payments.”
She added: ‘Data gathered by Quilter from the FCA shows there has been a near 120 per cent uptick in the number of people taking out mortgage terms of 35 years or more.
‘This highlights that more people are being forced to stretch their finances, opting for longer-term mortgages to manage monthly payments amid climbing interest rates and high house prices.
‘Strikingly, there is a significant increase in older borrowers who will still be repaying their mortgages well into their 70s, potentially diverting a considerable portion of their retirement savings to meet their mortgage obligations.
‘Looking forward, the pressures on affordability may lead to a downturn in house prices. The latest house price indices all point to declining or flatlining house prices.
‘However, prices will need to drop considerably or wages increase massively for the affordability ratios to improve.
‘While both are unlikely, the building of new homes to ease the supply and demand dynamic, and help first time buyers is likely to be a central battleground for next year’s election.’
Construction of new six-star rated offices for around 1400 Beca staff leaving Pitt St for the downtown waterfront Wynyard Quayside has reached level four of eight levels.
Scott Pritchard, chief executive of Precinct Properties –
The new homes on Roger St. Photo / Andrew Warner
Eight new houses will this week officially become part of Rotorua’s public housing offerings after a building programme on Roger St has been finished.
The new homes, which have two, three or four bedrooms, are part of 60 new houses under construction in the Pukehangi area by Government housing arm Kāinga Ora.
The homes will be blessed at 9am tomorrow at a celebration that is open for neighbours and anyone interested. Those attending can then have a chance to look at the new homes until 10am.
Kāinga Ora regional director Darren Toy said the organisation was pleased the homes were now finished and ready for whānau to move into.
Six of the eight homes are considered accessible for those with disabilities or the elderly and have been built by Kāinga Ora’s build partner, Penny Homes.
Toy said the homes made better use of existing land, as Kāinga Ora had replaced three older houses on large sections with single-storey and double-storey homes that were easy to maintain.
“We continue to work with urgency to plan and deliver more houses in Rotorua for those most in need of a warm, dry and suitable place to call home.”
New homes built by Kāinga Ora are given to people on the housing registrar who are most in need.
Kāinga Ora previously said it matched the homes with people depending on their circumstances and consideration is given to where the people work, their whānau, education and other factors.
The other new Kāinga Ora homes in the Pukehangi area will be on Quartz Ave (formerly Collie Dr), where 42 new homes were being built, and Gem St, where 10 new homes are being built, and all will be finished by the end of next year.
That international slowdown will limit the strength of the new Indian cycle, economists say.
Private investment in India was constrained for years by heavy indebtedness of companies and banks and by weak demand. But over the past two years, corporations and lenders have cut costs and raised equity capital, and companies have been able to spend on new capacity as demand has strengthened.
It has strengthened so much that productive capacity and working capital are now being used more intensively. That, in turn, is driving the higher demand for credit, said Swaminathan Janakiraman, managing director at India’s largest lender, State Bank of India (SBI).
“The capex that is taking place is generating financing requirements across the industry and the services sector and to a small extent there is a shift in borrowings from bonds to loans,” said Swaminathan. “Corporate credit demand has been low for too long and it is time for a pick-up.”
SBI expects its stock of corporate loans to rise by between 14% and 15% this year and by 12% a year on average in 2023 and 2024.
Across India’s banking sector, lending has been rising steadily. In the last two weeks of October, it was up nearly 17% on a year earlier. Lending to corporations, including small, medium and large businesses, was up 12.6% in September, the highest rate of annual growth since 2014, the latest sectoral data shows.
Sectors seeing strong loan demand range from infrastructure, to real estate, iron and steel and new economy segments such as data centres and electric-vehicle makers, said M.V. Muralikrishna, chief general manager for large corporate lending at Bank of Baroda, India’s second-largest state-owned lender. “Six months ago, the demand was mainly from the infrastructure sector, but it has now broadened out.”
Annual capital spending for India’s 15,000 largest industrial companies will be 4.5 trillion rupees ($55 billion) in the financial year to March 2023 and 5 trillion rupees in each of the following two financial years, forecasts Hetal Gandhi, director for research ay CRISIL Market Intelligence and Analytics. That spending will be about a third higher than the average in three financial years before the COVID-19 crisis.
“While the initial part of these investments were funded through internal accruals, borrowings from banks are rising and expected to grow further next year,” Gandhi said.
About a quarter of current capital expenditure is linked to a government manufacturing-subsidy scheme launched in 2021 called Production-Linked Investment (PLI), CRISIL estimates.
Dixon Technologies, an electronics manufacturer with annual revenue of about 150 billion rupees ($1.85 billion), will receive incentives under the scheme for setting up facilities in five sectors, including electronics.
The company expects to invest up to 6 billion rupees ($74 million) and is partly funding the expansion through bank debt, said Saurabh Gupta, its chief financial officer. “The borrowing environment is conducive and banks are willing to lend, particularly to companies under the PLI scheme,” he said.
The government also plans to spend a record 7.5 trillion rupees ($92 billion) on infrastructure in 2022-23, adding to demand for commodities such as steel and cement.
That has prompted Birla Corp to plan a $1 billion expansion of its annual cement manufacturing capacity to 30 million tonnes from 20 million tonnes. The company is partly funding that with debt but is wary of rising interest rates, said Harsh Lodha, chairman of its parent, MP Birla Group.
“Capex appears to show recovery, led by incipient signs of pickup in private capex and sustained support from public capex,” Morgan Stanley economists Upasana Chachara and Bani Gambhir said in a Nov. 14 report.
The economy was benefiting from post-COVID reopening, policy measures to reinvigorate capital expenditure, and stronger balance sheets in the private sector, they said.
A slowdown in global growth due to rising interest rates and pandemic restrictions in China presents a risk – or at least limitation – to this investment pick-up, however.
Already, October exports were lower than a year earlier, and Nomura economists cautioned in a note this week that India’s investment cycles were closely linked to its export cycles. So the current investment phase was not likely to be strong.
“October marks the first contraction in exports in the post-pandemic phase,” they wrote. “The last time exports contracted was back in February 2021 – attesting to the increasingly challenging global environment, and India’s sensitivity to this global slump.”
Credit Suisse economists noted that the weakness was broad. Only the electronics sector had seen higher exports in October.
(Reporting by Ira Dugal; Editing by Bradley Perrett)
By Ira Dugal