The mortgage horror is hurting younger buyers more than most. They tend to have the lowest mortgage equity and the biggest proportion of income heading out of their accounts each month to mortgage lenders.
Some relied on the bank of grandparents to help fund their initial deposit. The grandchildren may not be on the doorstep clamouring for assistance with repayments, but their worried grandparents – watching in horror as interest rates rise remorselessly – are certainly feeling under pressure to offer it.
Clients are beginning to ask the best way to gift now money they had originally earmarked for inheritance on death.
With inheritance tax (IHT) allowances frozen and receipts from the levy hitting a record £7.1bn in the recent tax year, a growing number of estates are expected to be caught in the IHT trap. It can make sense even for some in their 50s and early 60s to start a carefully considered programme of early giving – whether your grandchildren need it now or later.
Trusts and family investment companies
For wealthy households looking to gift large sums, the most flexible option may be to set up a single discretionary trust that covers all grandchildren (and future grandchildren).
Payments from this trust can be used to fund anything from school fees to house deposits and mortgages. There are several benefits to this.
Capital and income from the trust are distributed at the discretion of the trustees (who may include the parents), so there is more control over the money. This may not prevent a grandchild’s house becoming embroiled in a messy divorce, for example, but it can help. We encourage grandparents setting up trusts to write detailed guidance on how they want the money to be spent.
The trust will be liable to tax on growth of assets, but this is only paid on actual sale of an asset or when it is distributed to beneficiaries. It is also possible to use “holdover” relief on the way out of the trust so that the gain is charged to the grandchildren using their tax allowances and lower-rate bands. Usefully, any growth is outside the grandparents’ estates from the start.
Trusts have their own IHT regime. Gifts into trust are considered chargeable lifetime transfers (CLTs) by HMRC. This means they are taxed at 20 per cent of the gift if paid by the trust, or 25 per cent if paid by the grandparents. Thereafter they are assessed for IHT at a maximum of six per cent of the fund every ten years or on distributions of capital from the fund between anniversaries. Yes, it’s complex!
This regime may still be preferable to paying 40 per cent IHT, but it can be avoided altogether if you have not fully used your nil-rate band. The IHT nil-rate band is currently £325,000, which means that a couple could put £650,000 into a trust without generating an IHT entry charge. Please note that the residence nil-rate band is for death transfers only and so does not form part of considerations here.
This is one of the least understood tax breaks. If you die within seven years, the gift into trust uses all or part of your nil-rate band, meaning that less is available for your estate. If the gift was greater than the available nil-rate band then it is also reassessed at death rates – in other words 40 per cent. The liability for the extra tax falls on the beneficiary, so in this case the trustees. Donors often take out insurance to protect their grandchildren and the trust from an unexpected bill should they die before the seven years are up.
Survive seven years and any tax liability is washed away. This is what I call the Dr Who of tax allowances – it regenerates, giving you each a fresh £325,000 nil-rate band and the chance to make another big contribution.
Another way to help may be through a family investment company, where you structure the shareholdings so your grandchildren have shares and receive dividends. This can be done in conjunction with a trust. Like all gifts, the growth in value of the shares is outside your estate from the start.
Of course, these structures are relatively complex and incur set-up and administration costs. Other methods of giving may be more appropriate.
Gifts directly to grandchildren are known as potentially exempt transfers (PETs). As with the CLT, if you die within seven years of making the gift then it counts towards your nil-rate band. With PETs and CLTs, the IHT liability on gifts beyond the nil-rate band tapers over the seven years and is washed away at the end. We always advise people to keep a list of their gifts so that in the event of their untimely demise someone can work out the tax positions of the estate and previous donees.
There are other small allowances that are IHT-free, like wedding gifts and birthday presents. But for many people with high incomes, like those on generous final salary pension schemes earning more than they need, the most effective way to help grandchildren (and anyone else) with mortgage payments is to gift the excess each month.
Your estate may have to prove to HMRC that the gift was from surplus income, but that should be straightforward if you keep records of income and expenditure. Gifts out of surplus income are completely free of IHT – no tapering and no Dr Who regeneration!
So, a widowed client who is a retired senior civil servant earning a six-figure pension that is some way beyond his current needs, recently agreed to help two of his grandchildren, paying each £1,000 a month. One is using the money to offset higher mortgage rates and living costs, the other to pay extra on their mortgage before their current deal ends in 2026.
This helps prevent surplus income from building further within his estate, adding to his IHT concerns. He also reviewed his will recently and, after discussion with his daughter who is financially secure, agreed that on his death his assets will pass directly to the grandchildren. Skipping a generation prevents the daughter and her husband inheriting his estate and adding to their own IHT estate.
No gifting should be made without you being confident that it is affordable. Don’t forget your own costs and potential outgoings have risen. It is worth reviewing these before making any family commitments. For instance, costs of care have risen by 11 per cent in the last year alone, according to the UK Care Guide, and funds set aside as provision for this may no longer be sufficient.
If the gifts are affordable, however, giving in a structured tax-efficient way now can be not just an opportunity to help loved ones through the current crisis but also a sensible way of reducing the amount that may be paid in IHT later.
Tax laws are subject to change and taxation will vary depending on individual circumstances.
Clare Munro is a tax adviser at Weatherbys Private Bank.
*Featured on the Financial Times website on 7th July 2023: Tax tactics for the Bank of Gran and Grandad.