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A family posing for a photo on the beach in winter.

Benefits of an Early Inheritance

By Miranda Harding
Published 24 August 2022

More families than ever are gifting money to their children or grandchildren earlier than planned. Read our guide to inheritance.

In this guide

  • What is inheritance tax?
  • Passing on property
  • Gifting wealth
  • Unlocking equity
  • Retirement repercussions 
  • Stick to the rules

The pandemic has encouraged more families to bring forward plans to pass down their wealth to younger generations. A survey carried out by financial advice firm Kallik & Co in November found that a fifth of adults had started gifting to children or grandchildren earlier than planned. 

Gifting loved ones an early inheritance can reduce your inheritance tax liability while being emotionally rewarding too. But without carefully planning and an understanding of inheritance tax rules, your generous gift could come with a sting in the tail.

What is inheritance tax?

Inheritance tax is payable on your estate when you die. Your estate is the total value of everything you own when you pass away, including the value of your home, less the value of your debts. 

If your estate is worth less than £325,000, known as the inheritance tax threshold, or the nil-rate band, you usually have no tax to pay. Any portion of your estate that is valued above the inheritance tax threshold is taxed at 40%. You can leave any of your assets, inheritance tax-free, to your spouse or partner when you die. Any of your unused allowance can also be passed on to them.

Passing on property

There’s no inheritance tax to pay if you pass on your home to your husband, wife or civil partner when you die. 

If you pass on your home to a direct descendant your tax-free allowance increases from £325,000 to £500,000 following the introduction of an additional £175,000 allowance called the main residence ni-rate band in April 2017. Only children and grandchildren count as direct descendants. Step, foster and adopted children and grandchildren are included. Nieces, nephews and siblings do not. 

You can pass on this property allowance to your spouse or partner if it is unused. That means as an individual you could pass on an unused inheritance tax allowance of £500,000. As a couple you could pass on up to £1 million tax free.

If you want to pass on your home while you are still alive, you must survive the gift by seven years. If you die within seven years of gifting your home it will counted as part of your estate. 

Gifting wealth

Paying inheritance tax used to be a burden borne only by the wealthy. 

Since the £325,000 threshold was fixed 17 years ago, house price inflation has meant families who never thought they’d be snared by the tax man could end up paying a hefty sum from their estate.

With careful planning, however, you can lower or eliminate your inheritance tax bill by making financial gifts to family or friends during your lifetime to reduce the value of your estate. 

One way to do this is by gifting money to children. Almost four in 10 adults said they wanted to pass on a living inheritance rather than wait until they had died, so no surprise that the Bank of Mum and Dad is one of the UK's biggest mortgage lenders! By doing so you’ll have the satisfaction of seeing loved ones benefit from your hard earning savings. They’ll also be able to invest a living inheritance much earlier in their lives than if the money was bequeathed to them. Today’s 20 to 35-year-olds won’t receive an inheritance until they are aged 61, by which time most of their big life events are behind them. 

The average amount of money gifted in a lifetime is £58,439 compared to £70,639 left behind as an inheritance according to investment manager Fidelity International. Although the lifetime gift is smaller, if they invest it in a business, the stock market or a house during their early adult lives it will increase the value of the gift in the future. 

Unlocking equity

If your wealth has increased due to house price inflation you may not have spare cash to give away. 

Instead, you can unlock the equity from your home using a Retirement Interest Only mortgage or an equity release mortgage. Both mortgages are designed for older borrowers. By taking out a mortgage on your home to pass on a living inheritance, you are reducing the value of your estate when you die. That’s because the value of your debt when you die, including a mortgage, is deducted from the value of your assets to work out your Inheritance tax bill. 

An early inheritance could not only help your children or grandchildren get on to the property ladder, but it could unlock cheaper rates for them too. Borrowers with a 5% deposit, who need a 95% mortgage, will pay on average 3.06% for a two-year fixed rate deal, says data experts Moneyfacts. But those with a 25% deposit who need a 75% mortgage will be offered an average rate of 2.22%.

Over the course of a two-year deal, that’s a big saving. Based on a mortgage of £200,000 over 25 years, borrowers would save £2,064 in interest on the cheaper rate.

Retirement repercussions 

Before gifting an early inheritance, consider how the loss of wealth will impact your own retirement plans.

If you have saved hard all your life, it’s only fair that you should enjoy a comfortable retirement. If you give too much of your nest egg away to your family your retirement lifestyle could be compromised. Worse still, if you live longer than expected or suffer an illness you may lack the means to pay for care or support yourself later in life.

A financial adviser could help you assess your retirement savings, investments and property wealth to work out how much you can afford to give away. 

Stick to the rules

Gifting an early inheritance can reduce the tax liability on your estate, but only if you stick to the rules. 

The rules around exemptions and allowances can be complicated. Getting professional advice can help you avoid making costly mistakes.

Everyone gets an annual gift allowance of £3,000 while they’re alive which is exempt from inheritance tax. You can make gifts to anyone you like as long as the total amount does not exceed your allowance. On top of that, if you are giving money as a wedding gift you can give away up to £1,000 per person. This goes up to £2,500 for a grandchild and £5,000 for a child.

You can also give away unlimited gifts of up to £250 per person provided you haven’t used up another allowance on them. 

If you want to give away a larger amount of money, a different rule applies. You may have heard of the seven-year rule. If you live for more than seven years after making the gift, of any amount, it will be free from inheritance tax. If you don’t, inheritance tax may be owed.

The younger you are when you make a gift using this rule, the more likely you are to survive for seven years. But remember not to deplete your retirement pot by being too generous too soon. 

Speak to a Tembo mortgage adviser to find out how you can release equity with a Deposit Boost to help family members, or to discuss your later life lending needs. For IHT advice, seek guidance from a professional tax advisor.