What to know before giving a gift with strings attached

As inheritance tax (IHT) changes loom large, more people will be considering giving gifts during their lifetime to cut their tax bill. However, different gifting methods offer varying degrees of flexibility.

If the individual making the gift is not really ready to let it go, or they’re worried about what their family might do with the money, they might choose a method which allows them to retain some influence and offer so called ‘gifts with strings attached’. But this can come with financial and emotional consequences for all parties.

Gifts become more pressing with upcoming IHT changes

From next April, pensions will be drawn into the inheritance tax net. It’s estimated that will mean tax is due on an extra 10,500 estates in the same tax year, hike the amount of tax paid by 38,500 estates and increase the tax due by £34,000 each on average, according to HMRC. One of the most effective ways to manage an inheritance tax bill is by making gifts during your lifetime.

You have an annual gift allowance of £3,000 a year, which comes out of your estate immediately for IHT purposes. You can carry forward this allowance for one year. You can give up to £250 to any number of people too – although not to anyone who has received money through the annual gift allowance. You can also make specific gifts for weddings – however, the amount depends on who is getting married.

On top of that, you can give away lump sums of any kind, and they’ll fall out of your estate after seven years. These are known as potentially exempt transfers (PETs). You can also give gifts from surplus income, so once you meet your usual living expenses, you can give away income that’s left over if you do it on a regular basis.

Protecting your gifts

It’s only human to hope that whoever receives the gift makes the most of it. You may even want them to do something specific with it. If it’s a valuable item like jewellery or art, you may hope that they don’t sell them – and keep them in the family. There’s nothing stopping you from sharing these views.

You may also worry that if they are married – or planning to marry – that they might get divorced and lose the gift in any divorce process. In these circumstances some people will encourage the person receiving the gift to draw up a pre-nuptial agreement – or a post-nuptial agreement if they’re already married – designed specifically to protect the gift.

Going further

Some people will want to go further and make gifts on the specific condition that their loved ones do exactly what they want with it. This is where you can stray into financial and emotional beartraps.

We’ve looked at five things to consider before parting with a gift.

Five things to consider before gifting

1. Make sure you’re aware of the costs and admin involved when using trusts

Some people will consider trusts, which allow them to give something away by putting it into the trust, but not pass it directly to the person getting the benefit. Instead, the trust is run for them by the trustees. People will use them in order to maintain control over how the money is used, so the trust can be set up to pay for something specific. It might be set up to delay inheritance to a specific age, or it could be used to make controlled payments to the beneficiaries.

You need to consider how this will make the beneficiaries feel. Ironically a trust is often established because of a lack of trust. Personalities or circumstances may mean the donor doesn’t think it’s safe to hand the gift direct to their family. There’s no sugar coating this, and it could have repercussions for your relationship.

You also need to be aware of the costs involved. There could be up-front legal fees, which will depend on how complex the trust is. Then there are ongoing costs, including potential fees from professional – trustees, lawyers and accountants. There may also be tax to pay when you put assets into the trust or as you go along. If you set up a discretionary trust there may also be inheritance tax to pay when you set it up, every ten years and then again when the assets are given away.

If you choose to use family members as trustees rather than professionals, this will cut the fees, but it could leave them with more work than they might expect, including everything from tax returns to investment responsibilities. Potential trustees need to understand their responsibilities and be prepared to take them on. But trusts remain useful tools for estate planning, and those considering using them may wish to speak with a financial adviser to ensure they understand all the conditions of any given trust before they make the decision.

2. You could fall foul of inheritance tax rules

Some people will give away their property to their family, in the hope of getting it outside their estate after seven years have passed. They may be aware of the ‘gift with reservation of benefit’ rules that mean if you continue to get any benefit from the property, such as living in it without paying market rent, it’s not counted as being given away at all for IHT purposes.

However, they may not be aware that there are circumstances where a gift is given and the donor retains so much control over it that HMRC decides they have not been entirely excluded from benefiting from the property or other gift. This may mean it falls foul of the gift with reservation rules. This is a relatively grey area, but there might be circumstances, for example, where the property is given away, but the donor doesn’t allow any redecoration during their lifetime or insists their own furniture remains in situ, when it raises the question of whether this level of control is a benefit in which case it may not be counted as given away at all.

3. You could leave them with a tax bill they can’t pay

When someone dies, it’s their estate that’s liable for inheritance tax. However, there are exceptions to this. If they have given gifts worth up to the value of their nil rate band during the previous seven years, they are brought back into the estate on death. If they have given away more than their nil rate band, the gifts are brought back in chronological order. Once the nil rate band is used up, there’s tax to pay on any subsequent gifts. Taper relief may apply, and bring the rate of tax down, but it’s payable by the person who received the gift. If you were given one of these gifts, but the person giving it insisted you spent it on buying something, like a property, you may be left unable to pay the bill without borrowing the cash.

4. You could upset them

The person receiving a gift might be so affronted by your conditions that they refuse to accept the gift. Or they might feel you are being controlling or manipulating, so that even if they take the gift, it damages your relationship.

It means before you give a gift with strings attached, you should consider how important it is that they do as you want, and whether you could make your feelings known, but ultimately leave the decision up to them.

5. They might upset you

Someone might refuse to accept a gift that comes with conditions. This could derail the inheritance tax planning you wanted to do, causing family rows. Alternatively, they may take the money and ignore your wishes. Unless you drew up a trust or a contract, you’re unlikely to have any power to influence their decision, which could leave you feeling angry and frustrated.

When you’ve weighed up the potential costs and benefits, it may come down to how much you value the control. Are you happy to risk them refusing the gift or the process damaging your relationship? Or are you prepared to spend the money involved in drawing up and running a trust, in order to stay in the driving seat? If not, you can either trust them to do the right thing, or you may decide that you’d rather keep the money and pay the inheritance tax instead.