Inheritance Tax Grandchildren
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Inheritance Tax Grandchildren (Part 1)
Diarmuid Phoenix talks to us about how inheritance tax works when leaving assets to grandchildren.
What is inheritance tax and how does it apply when leaving assets to grandchildren?
Inheritance tax is essentially a tax on the estate when someone dies. It could be on property, money, or even possessions.
It’s applied before assets are distributed to beneficiaries, such as grandchildren. Other family members can inherit, as well.
Each individual has an allowance that they can leave tax-free – which I’m sure we’ll get onto later in the podcast. As long as they’re direct descendants, grandchildren can be included in that, as well.
Do grandchildren have to pay inheritance tax on their grandparents’ estate?
Yes. If inheritance is above the Nil Rate Band threshold of £325,000 they’ll have to pay inheritance tax, even as the deceased’s grandchildren.
Is the inheritance tax rate different for grandchildren compared to children? Does the inheritance tax threshold increase if assets are passed to grandchildren instead of children?
The inheritance tax rate is exactly the same for grandchildren as it is for children. Above the threshold, the rate of tax is 40%.
The answer to the second part of the question is also no. The tax threshold won’t increase if assets are passed to grandchildren instead of children. It’s the same.
Are grandchildren considered direct descendants for inheritance tax purposes?
Yes. Grandchildren are considered direct descendants for inheritance tax purposes. The definition allows biological, adopted and step-grandchildren to be included.
What is the current inheritance tax Nil Rate Band for leaving assets to grandchildren?
It hasn’t changed in quite some time. There’s been talk amongst various different governments about changing this, but it hasn’t yet.
The current Nil Rate Band for leaving assets to anybody, whether they are grandchildren or not, is £325,000 for each individual. It can be higher than that – and we’ll come onto this shortly [all information correct at the time of recording in October 2025].
How does the Residence Nil Rate Band work when leaving a home to grandchildren?
The Residence Nil Rate Band (RNRB) is an extra inheritance tax allowance on top of the standard Nil Rate Band of £325,000.
The RNRB applies only when your main home is left to direct descendants, which can include grandchildren. It amounts to £175,000 per person and can be combined with the Nil Rate Band. So, potentially you could pass on as much as £500,000 tax-free per person.
This can again go to grandchildren if that’s what the testators wished.
Can unused inheritance tax allowances from a spouse be transferred when leaving assets to grandchildren?
Yes – so in theory it could double a couple’s allowances. Each individual can pass down £325,000 free of inheritance tax.
For married couples, on the second death you can use any unused threshold. So if the first person to die had not used any of their allowance during their lifetime, the surviving spouse can use it in full.
For example, the first person to die hadn’t gifted anything in the last seven years of their life, which would have accrued an inheritance tax liability. And they hadn’t used any of that £325,000 Nil Rate Band. Once they die, the unused £325,000 transfers to their surviving spouse. So in effect, the surviving spouse can pass down up to £650,000.
Equally, the first person to die may have gifted something which meant they used £100,000 of their Nil Rate Band Allowance. The remainder of that can also be transferred to the surviving spouse.
Are there special exemptions for small gifts to grandchildren during my lifetime?
Yes, there are several exemptions for smaller gifts to children or grandchildren. There’s an annual exemption of £3,000 per tax year that people can give. There’s also a small gift exemption of £250 per person per tax year.
Then there’s a wedding or civil partnerships gift of up to £2,500 for a grandchild. It’s actually £5,000 for a child, so it reduces for grandchildren.
You can also make regular gifts from your income and larger gifts as Potentially Exempt Transfers. The seven-year rule applies here.
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Can setting up a Trust for grandchildren reduce inheritance tax?
Yes, it’s possible to mitigate inheritance tax using Trusts for grandchildren or anyone else. It will depend on the type of Trust, the timing and the value of the assets you put into it.
We could host another entire podcast to cover this sort of thing, but most of it centres around the seven-year rule. There are exceptions, but usually the seven-year rule means gifts fall out of the estate for inheritance tax purposes.
A taper relief applies as well, so there’s higher tax to pay in the first few years, but once the seven years have passed, the gift falls out of the estate. The same goes for most Trusts.
How are Bare Trusts versus Discretionary Trusts treated for inheritance tax purposes?
This follows on perfectly from what we’ve just been talking about. Bare Trusts are treated as a direct gift to the grandchild, and therefore a Potentially Exempt Transfer. There’s no inheritance tax at all if the donor survives for seven years.
With Discretionary Trusts, there’s an immediate 20% inheritance tax charge on amounts over the £325,000. But again, assets are outside of the estate after seven years.
Does paying for a grandchild’s education count as a gift for inheritance tax purposes?
Paying for a grandchild’s education can be exempt from inheritance tax, but it will depend on the source it’s paid from.
If the payments come from your normal income and not from savings or capital, education payments are not usually counted as gifts for inheritance tax purposes.
However, if gifts are made as a one-off lump sum, such as paying money into a grandchild’s school fund; or are made from savings and investments rather than income, they are treated as a gift of capital and the seven-year rule will apply.
How far in advance do gifts to grandchildren need to be made to avoid inheritance tax (IHT)?
It depends on the type of gifts, which we’ve alluded to already. Potentially Exempt Transfers or PETs will have to be made seven years in advance of death to be fully exempt from IHT.
For certain other gifts, such as annual exemptions, weddings, small gifts and gifts from surplus income, there’s no need to wait seven years.
Have we covered everything we need to in this episode?
I think we’ve covered it. We could dive deep into this over many podcasts, and hopefully we will return to this topic in the future.
Key Takeaways:
- Inheritance tax is a tax on an individual’s estate upon their death, applying to property, money, or possessions before distribution to beneficiaries like grandchildren.
- The standard Nil Rate Band (tax-free allowance) is £325,000 per individual, and grandchildren are considered direct descendants for this purpose.
- The Residence Nil Rate Band (RNRB) is an additional £175,000 allowance per person when a main home is left to direct descendants, potentially allowing up to £500,000 to be passed on tax-free per person.
- Unused inheritance tax allowances from a deceased spouse can be transferred to the surviving spouse, potentially doubling their combined allowance.
- Certain gifts, such as annual exemptions (£3,000), small gifts (£250 per person), wedding gifts (up to £2,500 for a grandchild), and regular gifts from income, can be exempt from inheritance tax without the need to wait seven years. Potentially Exempt Transfers (PETs) and most Trusts require the donor to survive for seven years for the assets to be fully exempt.
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