Gifting to save inheritance tax – level up your plans
Financial Adviser, James Atkinson gives his top tips for navigating inheritance tax and gifting rules.
Last Updated: 29 March 2023
Gifting your money throughout your lifetime can be a good way of reducing your beneficiaries’ inheritance tax (IHT) bill. But it’s often overlooked or left too late. So, whether it’s something you’re looking at for the first time or just as a refresher, here are some of the fundamentals.
See whether you could be impacted by inheritance tax by using our IHT calculator.
This article isn’t personal advice. Inheritance tax can be complicated, if you’re at all unsure of a course of action then you should ask for financial advice. Tax rules can change and any benefits will depend on personal circumstances.
Getting the basics in place
Before we even get into gifting, get the foundations in place by asking yourself:
- Who do I want to benefit and when?
- How much can I afford to gift bearing in mind future expenses like care costs or rising living costs?
- Do I have an up to date and valid Will?
- Have I written a Power of Attorney?
- Have I discussed my plans with my family and solicitor?
If you haven’t given any of these questions any thought yet, then it could be a good idea to think about addressing them first.
Gifting allowances
Here are a number of gifts you can consider making which are immediately exempt from IHT.
- Every tax year you can gift £3,000 without it being counted as part of your estate. You can also carry forward any unused annual exemption to the following tax year, but only for one year. This is available per person, so a couple could use their combined annual exemptions.
- Wedding or civil ceremony gifts are exempt up to £1,000 per person, or up to £5,000 for a child and £2,500 for a grandchild or great-grandchild.
- Gifts to charities (UK registered) and political parties are usually immediately exempt as well.
Although these exempt amounts might seem relatively small, gifting in these ways over time can add up to a big difference.
Numbers in action:
Say you didn’t use your £3,000 per year gifting allowance for 10 years. That would be a total of £39,620* which (if it formed part of your estate and was over the £325,000 threshold) would be taxed at 40%. So, your beneficiaries would only receive £23,772.
But if you gift £3,000 a year and your beneficiary invested that at the start of every year over that 10 year period, they could see growth of around £9,620*. A much better result than losing £15,848 to the tax man.
*Assuming the underlying investments were able to achieve an annual rate of growth of 5% after charges.
Remember, as a couple, you can gift £3,000 per tax year each. So your beneficiaries could benefit even more.
Don’t forget all investments can fall as well as rise in value, so you could get back less than you invest.
This example shows that planning well in advance could have a significant impact. But if it’s left to the last minute (or not done at all) it won’t have as much of an impact.
Remember, if anyone you want to gift to is under 18 (e.g. younger grandchildren), you could gift into a Junior ISA or Junior SIPP where it can be invested for their future. Once in a pension these gifts can only be accessed from age 55 (from 57 in 2028 and could change again in the future).
PETs and gifting from income
Often overlooked, gifting out of surplus income can also be immediately exempt. To qualify there are some criteria that need to be met. The gifts would need to form part of your normal expenditure, be made from income (not capital) and leave you enough to maintain your normal standard of living. The definition of ‘normal expenditure' can be a sticking point so it’s sensible to keep very clear records.
If any gifts you make exceed an allowance, they’re usually classified as potentially exempt transfers or PETs for short.
There’s no limit to how much you can gift as a PET, however the value of the gift would only be exempt from IHT if you survive for seven years after it’s made.
If you pass away within this seven-year period, the gift becomes chargeable and would then increase the overall tax bill. But how much tax is paid will depend on when you pass away during that 7-year period.
Your executors can claim taper relief which reduces the tax payable on the excess you’ve gifted over your available nil rate band. This relief is available between three and seven years after the gift is made. The longer the period between transfer and passing, the greater the taper relief and therefore the lower the tax bill.
Numbers in action:
Let’s say you made a gift of £375,000 on 1 January 2020 and then pass away on 1 February 2024. The gift exceeds the available nil rate band of £325,000 by £50,000. So this would be subject to inheritance tax at 40%, resulting in tax of £20,000. However, because the gift is within four to five years of passing, taper relief will reduce the tax bill. In this case from £20,000 (40%) to £12,000 (24%).
Trusts and other tools to think about
Making outright gifts often means giving up access and control of the money gifted. There might be circumstances where you want to have more control. Gifting money into a trust can provide you with a degree of control over who can receive the money, when and for what purpose.
Using trusts can come with extra complexity. But used in the right way, they can help your loved ones keep hold of more of their inheritance.
Gifting money into most trusts is classified as a chargeable lifetime transfer (or CLT, for short). This means any money gifted over the £325,000 IHT threshold will be taxed at a lower lifetime rate of 20%. Although, if you die within 7 years of the gift being made, further IHT of up to 20% may be payable.
As with lots of financial planning tasks, the most difficult bit is applying them to your specific circumstances. Here are some other tools and scenarios to think about.
Life assurance policies – depending on your situation, a life assurance policy could be a good option. Typically the policy would be held in trust. This means if you pass away the policy will pay out immediately, and could be distributed to your beneficiaries without forming part of your estate. Premiums would need to be kept up for the policy to pay out and could be quite high depending on your age and health.
Consider the order in which gifts are made – it’s important you plan when and how you gift for your particular situation. If you’re mixing the way you gift, timing is everything and it’s important that clear records are kept of any gifts and thought is given to how they might interact with each other.
Gift with reservation rules – these rules prevent people making gifts while still retaining the benefit of the asset they ‘transferred’. A common example is where someone gifts their home to a beneficiary but still lives there without paying fair value for its use (known as a market rent).
Gifting assets – when gifting any assets you have to be mindful of the potential tax implications like capital gains tax, and how assets held within a trust would be taxed.
Gifting to charity – leaving some of your money to charity can also help reduce any IHT bill, as well as being able to help a cause you care about. This is called leaving a ‘charitable legacy’. If you leave at least 10% of your net estate to charity in your Will, it would cut the IHT rate applied to the remainder from 40% to 36%.
Effort vs reward of gifting
Managing how we might financially help our children, grandchildren, charities and chosen beneficiaries can be a thought-provoking exercise. There’s a lot you can do to make sure those who you want to benefit end up with more, while working within HMRC’s rules. Whether that’s helping a child or grandchild get onto the property ladder or help with student debt, or being as philanthropic as you can to the causes close to your heart.
Gifting can play a large or small part of your overall IHT planning. If you think you need help in this area, our advisers can explore a range of ways to help you pass on wealth while trying to limit the impact of tax. Of course it will depend on your situation and you might also want to involve your solicitor and tax adviser.
Could our advisers help you with IHT planning?
A call with our advisory helpdesk is the first and most important step towards getting IHT advice. It will help you:
- Discover if advice is right for you
- Understand the benefits and cost
- Decide which of our advisory services might suit you best
You won't get personal advice on the call and there’s no pressure to take advice. Only if it’s right for you, will we book your free initial consultation with one of our specialist Financial Advisers.
