MANY people have the entirely altruistic notion of gifting money to their grandchildren, but they may not be aware of the potential tax implications that they face in spite of such generosity.
Whether you’re pitching in during a tough financial time, paying a portion of the cost of their education, or just saying “happy birthday”, there are several ways to help your grandchildren financially whilst also doing it wisely.
Before you give any financial gifts to your grandchildren, however, it is important to fully understand the tax legislation such gifts may fall under.
If you do wish to gift money to your grandchildren to encourage them to save or to give them a nest-egg when they leave home, then you may, under certain circumstances, have to pay tax on the interest.
At this point, I should make it clear that if you are a parent or a step-parent making the financial gift then there’s no limit on how much you can give or invest for your children.
But the interest might be taxed as your income if:
- you are the child’s parent or stepparent and your child is unmarried, not a civil partner and under age 18;
- the interest is more than £100 in a year.
It is also worth bearing in mind that each parent will have a separate gift allowance to utilise – each will have a separate £100 limit. So if both parents contribute equally, their child could earn up to £200 worth of interest each year without either of the parents having to pay tax on it.
One should also note that there’s a separate £100 limit for each step-parent too.
Financial gifts made by grandparents and carers
The £100 limit mentioned above only applies to parents and step-parents. As a result, grandparents can give as much as they like to their grandchildren or other people’s children – and the interest won’t be taxed as their income. However, the children may be eligible to pay inheritance tax on the amount they receive and may also have to pay tax on interest from the income of their savings.
With regards to the tax on children’s income, it is highly likely that your grandchildren will have a full personal tax-free allowance each year (£7,475 for the 2011-12 tax year) to offset against tax. This means they can have income (including interest and dividends) of up to this amount in the current tax year without paying any tax. Therefore, only very substantial income-producing gifts are likely to pose any real tax consequences for your grandchildren with the vast majority of gifts implying no additional tax liability on the recipient child.
If you give money to your grandchildren (or to children you care for), inheritance tax exemptions may mean that tax does not have to be paid on it. Although, if you die within seven years of giving the money there might be some to pay, depending on the type and value of the gift made.
Collective investment schemes for grandchildren
For those grandparents who wish to give money or assets to their grandchildren, it’s important to consider why the investment is being made and what type of investment would be most appropriate.
Short-term investment needs would be best catered for using a bank or building society account or a National Savings and Investments product in order to preserve the capital value of the monies gifted.
Conversely, if the investment needs to be for the long term, a collective investment may be more suitable, as it will allow the investor to spread the investment risk for even a fairly small sum. Many collective investment schemes also have access to a multitude of investment funds, enabling access to a number of different investment themes and sectors.
Unfortunately, the collective investment scheme cannot be set up in the child’s name, so the individual (grandparent) making the “gift” must apply for it and hold it in his or her own name, but for the ultimate benefit of the child.
Depending on how this is achieved will affect the tax consequences for both the child and the adult donor. If the investment is for the benefit of one or more individuals, an investment account can be set up under a designated account in one of two ways.
The basis of taxation will be determined by whichever method is selected. The two options are “irrevocable” and “revocable”.
Irrevocable basis
The irrevocable basis is chosen where the individual wishes to gift the investment to a child. Where the gift is to more than one child, each child will receive an equal share of the investment.
By setting up the investment account under an irrevocable designated account, the investor creates an absolute trust in favour of the child (beneficiary). This means the individual who sets up the account cannot access the funds for his or her own benefit or indeed change who will receive the funds. Furthermore, when the child reaches the age of 18, he or she becomes legally entitled to his or her share of the funds.
- Tax consequences
- Inheritance tax – the investor is making a potentially exempt transfer (gift). The gift may already be exempt if it falls within the annual exemption, or if it qualifies as normal expenditure out of income. If it is not exempt, it will fall out of the estate completely after seven years and taper relief may reduce the amount liable to inheritance tax on the death of the investor within seven years.
- Capital gains tax – the beneficiary will be liable to any capital gain realised and will be able to use his or her full available annual exemption. This applies even if the account has been set up by the child’s parent.
- Income tax – if the account has been created by anyone other than a parent of the child beneficiary, any income tax liability will fall on the child and again he or she will be able to use all of his or her available personal allowance. However, as already mentioned above, if the account was created by a parent for a minor unmarried child and the amount of gross income generated exceeds £100 per tax year, the parent will be assessed on the total income, not just the amount that exceeds £100. If the income in any tax year is less than £100 it will be assessed on the child.
Revocable basis
If the account is set up under a revocable basis, no trust is created. Consequently, no gift has been made and all income tax and capital gains tax liabilities remain with the investor. The investment remains inside the person’s estate for inheritance tax purposes. This means that grandparents can access the funds at any time and redirect as they see fit, including to themselves.
Summary
Given the recent rises in university fees and significant barriers to getting on the UK property ladder, the concept of gifting money to one’s grandchildren has become increasingly popular. However, given the complicated tax treatment surrounding this issue and the multitude of investment options available to investors, the concept can appear somewhat daunting.
It goes without saying, therefore, that it is vital appropriate advice is taken to ensure things are completed and documented properly. Failure to do so may result in tax penalties or charges which may undermine the benefit of making the gift in the first place.
