Generous presents to keep away from inheritance tax can backfire in case your youngsters get divorced, attorneys warn
Wealthy parents making gifts to avoid inheritance tax are attaching strings to prevent family assets getting lost in a divorce, say lawyers.
Some are asking for pre or post-nuptial agreements to ringfence an inheritance, while others are skipping a generation and setting up trusts for grandchildren, they explain.
Gifts are one of the simplest ways to reduce an inheritance tax bill, because they become exempt from tax if you live for at least seven years.
If you die before the seven years are up, inheritance tax is levied on a sliding scale.
But law firm Hodge Jones & Allen says it is seeing increasing numbers of parents who regret gifts made in haste, particularly large sums of money or property.
‘It then dawns on them that those assets could, at least in part, end up with their child’s partner or spouse in the event of a split,’ says family lawyer Vanessa Friend.
‘Perhaps they didn’t realise the marriage was struggling or that inheritance can still be shared in divorce settlements, particularly if it includes a property where the family live.’
Gifting to avoid inheritance tax: Assets can be lost in a divorce if you give them away to family members
More families are now planning ahead for inheritance tax because it will start being imposed on unspent pension pots as well as other assets from April 2027,
Inheritance tax is levied at 40 per cent on estates above a certain size, but you need to be worth at least £325,000 if you are single, or £650,000 jointly if you are married, to pay it.
A further allowance for those who leave their home to direct descendants raises the threshold to £500,000 per person or £1million for a couple.
Money experts warn against handing over a home you live in to your children before you die, because HMRC would consider it a gift made with ‘reservation of benefit’ and impose inheritance tax anyway, unless you follow strict rules.
There are also many other risks, including half your home ending up belonging to your child’s ex in a divorce, and potentially being sold out from under you.
Friend says parents who make gifts without thinking it through might belatedly try to persuade their children and their partners to sign a postnuptial agreement.
‘This can be a very tricky conversation to have, with spouses understandably nervous about signing away any entitlement and neither party wanting to broach the possibility of a relationship breakdown.’
She says that if an inheritance was received prior to marriage, it is generally considered a non-matrimonial asset and may be ring fenced in the case of divorce.
But Friend explains that if it is received during a marriage and mingled with matrimonial assets or used for the benefit of the family, perhaps to buy a family home, it may be considered a marital asset and part of any divorce settlement.
A pre or post-nup can get around this by setting out how assets should be treated in the event of a divorce, but spouses drawing up such agreements will need to demonstrate the agreement was entered into freely and is fair to both parties, adds Friend.
‘I would urge parents considering gifting to their children to take into account the status of their romantic relationships before doing so.
‘If they are married or in a civil partnership, or if this is on the horizon, then consider a prenup or postnup as pre-requisite of receiving the gift. If there is a concern that the relationship may not last, perhaps adopt a wait and see approach.’
She says other options are to ask your children to avoid mingling the assets with shared money during the marriage or to consider placing the money in trust for the benefit of grandchildren.
How to suggest a pre or post-nup to your married children
Raising the possibility of pre or postnup is difficult and can cause feelings of mistrust or a suggestion that the relationship won’t last, writes Vanessa Friend of Hodge Jones & Allen.
Parents will need to broach the topic sensitively and not rush things. Whatever the approach, the gifting parent should consider legal advice on the future status of the asset if the marriage were to break down.
Consider a family discussion about why you intend to the gift the assets and your expectations as to what will happen to them,
You can explain, for example, that you are planning on moving out and giving them your house, but that this is on the expectation that it will stay in the family for the next generation or in the event of separation.
Vanessa Friend: Parents will need to broach the topic sensitively and not rush things
When the pre-or postnup is drafted you can include a clause stating specifically that a family home will not be shared in the event of divorce because it is an inherited asset.
You can include clauses setting out how quickly the spouse will need to move out of the property on separation.
You could also consider a clause to deal with your children’s spouses who work in the family business.
For example, even though the spouse is working for the family business or is living in a family property, they will not be entitled to a share.
The key will be to ensure the agreement is still fair to them to reduce the chances of a court saying the prenup should not be upheld.
You also need to make sure your child is fully aware of the assets you are gifting, so that they can make full financial disclosure when entering into the prenup. A failure to disclose fully can lead to the prenuptial agreement not being upheld.”
James Ward, head of private client at Kingsley Napley, says: ‘There is definitely an increase in gifting activity going on.
‘Some clients are wary about giving to their children because of the risk family wealth may form part of a future divorce.
‘I see parents insisting on pre and post nups to ringfence any gifts as far as possible and making the existence of such an agreement a condition of passing down any financial gifts or prescribing a future inheritance.’
But Ward says he finds in some cases people are happier making the gift to grandchildren via bare trusts.
‘This money can be invested and used for education and maintenance and can take advantage of the grandchildren’s personal income tax allowance.
‘It’s a safer gift in many ways and the grandparents get to see the benefit, particularly with private education, which is more costly than ever.’
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