Transferring wealth through generations is a common way to leave behind a financial legacy within families, yet open conversation about how much our children are likely to inherit when we die is often avoided.

Communication poses a huge problem

Talking about money can still be considered a difficult topic in some families, and it’s this mentality, and the subsequent lack of communication, that could make preparing for wealth transfer from one generation to the next much more challenging and it has left many in the next generation unprepared to receive significant wealth. The solution to preparing children to inherit your wealth is to have an open and honest communication about money with them before they receive any inheritance. This does not mean that they need to know how much money you have or see copies of your financial statements or financial plan, it just means that you should prepare them in advance.

From school and university fees to deposits for a house purchase, gifts of money from parents and grandparents could make a real difference to children’s lives. And based on the current Inheritance Tax (IHT) exemptions, giving little and often could help you mitigate any IHT liability you may be facing.

Difficult topic for many families to discuss

It’s common for people in their late 20s and 30s to need the most financial help. They could be in the early stages of their career or trying to get on the property ladder and starting their own family. These are the times in people’s lives when a financial gift from parents or grandparents could make a life-changing difference. Gifting early could also help them flourish and build their own legacy, as early access to capital could create more opportunities.

While basic questions about money can help start the conversation, it’s likely that this process will unearth even more questions. Will your children understand all the hard work that went into creating your wealth in the first place? Can the family work together to manage its wealth, or will it create anxiety and disagreements within the family dynamics?

Here are a few options you could consider when thinking about helping your family financially. Please bear in mind that IHT liability and mitigation is a complex area, and this article provides a simplified overview. As there are a wide range of exemptions and allowances to consider, you should always seek advice from a qualified professional.

Seven year rule

As property values continue to rise, some families may be looking at ways to reduce an IHT liability as part of their intergenerational wealth transfer planning. Gifting to children or grandchildren while still living is an effective way to do this, as well as being helpful for your children, however there are various rules that you must consider.

If you make ‘early inheritance’ gifts, seven or more years before your death (‘the seven-year rule’), the giftee won't have to pay IHT. The people you give gifts to will only be charged IHT if you give away more than £325,000 in the seven years before your death, although only the balance over £325,000 will be taxed retrospectively. This is known as the nil rate band (NRB).

As this is a simplified overview, we have detailed a few key points to consider when thinking about making gifts and you should seek advice from a qualified profession to ensure gifting is right for you:
• Lifetime gifts are taxed at 20% if the nil rate band has already been used up by chargeable transfers in the previous seven years.
• A chargeable lifetime transfer can affect other gifts in the cumulation for up to 14 years before death (the 14-year rule).
• Chargeable transfers including failed PETs (Potentially Exempt Transfers) in the seven years before a trust is created can reduce the available nil rate band for periodic charges.

In addition to the NRB you can also take advantage of the Residence Nil Rate Band (RNRB), which for the current year is £175,000, giving a combined allowance of £500,000. The RNRB does have some stipulations, and to be eligible for the RNRB you must pass your home or a share of it to your children or grandchildren. This includes stepchildren, adopted children, foster children but not nieces, nephews, or siblings.

Sliding scale of liability

If you die within the seven-year period, there’s a sliding scale of liability. For example, your beneficiaries would pay 40% if you died within three years, and 24% if it was between four and five years. It’s also worth noting that you can give away £3,000 worth of gifts each tax year without them being added to the value of your estate.

If you’re planning to give away money or assets to mitigate IHT, it's important to make a record of what you gave, who you gave it to, when you gave it, and how much it’s worth.

Gifts out of surplus income

One of the most popular ways to make regular financial gifts is by giving away surplus income, which is any remaining income you have after all of your outgoings have been paid. The rules for ‘normal gifts out of surplus income,’ allow wealth to be passed down on a much greater scale while remaining exempt from IHT. The gift(s) must be part of a regular pattern – monthly, quarterly, annually, perhaps – and must come from income, not capital.

To qualify to gift out of surplus income, the gift must be maintained over more than one tax year and the donor must show that it comes from income they do not need to maintain their own standard of living; otherwise, it will be treated as a series of lump sums and taxed accordingly. There is no monetary limit on this exemption.

Making regular gifts

Parents could, for example, set up a tax-efficient Junior Individual Savings Account (JISA) for a child and add to it every birthday; or they could make regular gifts to help them save up for university fees.

It’s good to give; here are some examples how you can gift:

• You can give away up to £3,000 per tax year, which is immediately considered outside your estate. This can be carried forward by up to one tax year, or £6,000 in the first year.

• A couple that has made no previous gifts could give away up to £12,000 with this exemption.

• Regular gifts from surplus income are also immediately exempt.

• Smaller gifts for Christmas, birthdays or weddings are also usually exempt up to certain limits.

• If your child is getting married, you can gift them £5,000; if a grandchild or more distant descendent is getting married, you can gift them £2,500; and to a friend or anyone else you know, you can gift £1,000.

• Donations to charity, political parties, universities, and certain other bodies recognised by HMRC.

However, you should always make sure you have an easily accessible cash reserve, to cover any urgent bills or ad hoc expenses, as well as ensuring that you don’t need to make any unplanned withdrawals from your investments. And you should not give away more than you can afford.

Junior pensions for children

Parents can set up Junior Pensions for children and contribute up to £2,880 a year (for the current tax year), topped up by the Government by £720 (tax relief at the basic rate of Income Tax at 20%). This can be done for all of their children aged under 18.

Once the Junior Pension is set up, other relatives such as grandparents, great-grandparents and even friends can pay money into it, as long as the combined annual contributions do not exceed £2,880 net (£3,600 gross) per child per annum. The earliest retirement age is currently 55 and it will rise to 57 from 2028.

Please note: This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

The content of this article was accurate at the time of writing. Whilst information is considered to be true and correct at the date of publication, changes in circumstances, regulation, and legislation after the time of publication may impact on the accuracy of the article.

The information in this article is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change and tax implications will be based on your individual circumstances.

The Financial Conduct Authority does not regulate advice on taxation or Estate Planning.

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