I am intending to give my children £20,000 each when I downsize. This will leave my current estate £60,000 under the inheritance tax threshold. At what stage will this become a problem? I am 74.
When you ask at what stage this will become a problem I assume you mean in terms of having to pay Inheritance Tax Allowance (IHT). Well the current personal IHT free allowance is £325,000, this is the amount up to which an estate will not have to pay IHT.
If your estate when you die is - including any assets held in trust and gifts made within seven years of death - more than £325,000, IHT will be due at 40 per cent on the amount over the nil rate band.
You don't mention how many children you have so I can’t tell how much money you plan to gift away. If for example you have 4 children to whom you gift £20,000 each (these gifts are deemed Potentially Exempt Transfers or PETs) and you were to die within 7 years of making these gifts then your total estate and gifts would be in excess of the IHT limit – and IHT may be payable.
This is because gifts always use up the Inheritance Tax threshold first before the value of any other assets or property that you leave behind. That means that until 7 years have passed there is a chance that IHT will be payable on your estate. Gifts are removed from the IHT calculation after 7 years from the date they were made. So that means:
- if you die within 7 years of the gifts and the seven-year running total of PETs (those to your children plus any others), chargeable gifts and your estate comes to less than the tax-free allowance, no tax will be due.
- if you die within 7 years of the gifts and a sufficient amount of tax-free IHT allowance has been used up against the PETs to your children (or by another other PETs or taxable lifetime gifts) so that the balance of the allowance is less than the value of the rest of your estate, then IHT will be due.
So until 7 years have passed you are very close to your IHT allowance and if your estate grows there's a good chance you will pay 40% IHT on the portion of your estate over the IHT free allowance.
As I’ve said, after 7 years (when you are 81) the PETs will drop out of the IHT calculation which will give more wiggle room before your estate exceeds the IHT free threshold. In this instance when will IHT once again become an issue? - well on the basis that you are currently around £60,000 below the threshold (ignoring the PETs) and assuming an annual net growth rate in the value of your estate of 3% a year (I’ve plucked this figure out of the air but it is about the best savings rate at the moment) your estate will breach the IHT threshold in around 7 years, assuming the IHT free allowance remains at £325,000.
Obviously this assumes your estate actually grows and that you are unmarried or widowed, as you do not mention a spouse. If you are married then it may be possible to arrange your affairs in order to utilise your spouse’s IHT allowance as well, in which case you will be able to avoid IHT altogether assuming their estate is relatively small.
But there are other things you can do to reduce your potential IHT bill - read my guide 15 ways to slash your potential IHT bill.
I hope that helps
Money to the Masses