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  • The essential guide to Inheritance Tax

    How much do you know about inheritance tax and gifting? Here are our top tips.

    Last Updated: 6 April 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.

    This guide 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. We can advise you on how to make use of tax allowances but if you need complex tax calculations we recommend consulting an accountant or tax specialist.

    Tax rules can change and any benefits depend on personal circumstances.

    Getting the basics in place

    Before we even get into gifting, get the foundations in place by asking yourself:

    1. Will I be affected by Inheritance Tax at all?
    2. Who do I want to benefit and when?
    3. How much can I afford to gift bearing in mind future expenses like care costs or rising living costs?
    4. Do I have an up-to-date and valid Will?
    5. Have I written a Power of Attorney?
    6. 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.

    Who has to pay inheritance tax?

    Not everyone has to pay inheritance tax. Here are the rules.

    IHT is usually paid at 40% on the value of your estate (your property, money and possessions) over the £325,000 allowance (the normal nil rate band). There’s also an additional allowance of up to £175,000 if you pass on your family home to children or grandchildren. And, for any joint assets, you only include the value of your share.

    If you’re married or in a civil partnership you can combine your allowances and transfer assets between each other free of IHT. When one dies, the surviving spouse won't have any IHT liability and you might be able to make use of the IHT allowances which were unused by your late spouse/partner.

    See whether you could be impacted by inheritance tax by using our IHT calculator.

    Please note: The calculator is a general guide and not personal advice. For confirmation of how inheritance tax might affect you please seek advice.

    Use our calculator

    4 ways to make gifts and save IHT

    Gifting is the most accessible tool for reducing your potential inheritance tax liability. Here are some of the gifts you can make within the rules.

    • 1.   Annual exemptions
    • 2.    Marriage gifts
    • 3.    Donations to charities or political parties
    • 4.    Gifts from income

    Gifting allowances

    There are a number of gifts you can make which are immediately exempt from IHT.

    • Every tax year you can gift up to £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

    You can also give up to £250 per tax year to any number of people, provided they haven’t received a gift from you which uses another exemption. 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 assuming tax rules stay the same. 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% on your death. So, your beneficiaries would only receive £23,772 (instead of the £30,000 you could have given them IHT-free).

    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.

    Remember, a couple can gift £3,000 per tax year each (£6,000 in total). So your beneficiaries could benefit even more.

    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 Junior ISA these gifts can be accessed when the child turns 18 and in a Junior SIPP when they turn 55 (57 from 2028).

    *Assuming the underlying investments were able to achieve an annual rate of growth of 5% after charges. Don’t forget all investments can fall as well as rise in value, so you could get back less than you invest.

    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 to individuals do not qualify for an exemption, 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. 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 the transfer and your passing, the greater the taper relief and therefore the lower the tax.

    Number of years survived Reduction in tax Effective tax rate
    0-3 0% 40%
    3-4 20% 32%
    4-5 40% 24%
    5-6 60% 16%
    6-7 80% 8%
    7+ 100% 0%

    Numbers in action:

    Let’s say I made a gift of £375,000 on 1 January 2016 and I pass away on 1 February 2020. The gift exceeds my available nil rate band of £325,000 by £50,000. So £50,000 would be subject to inheritance tax, which would usually result in tax of £20,000. However, because the gift is within three to four years of my passing, taper relief will reduce the tax bill. In this case from £20,000 (40%) to £16,000 (32%).

    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 won’t be exempt from inheritance tax, but it will be immediately taxed at a lower lifetime rate of 20%. Although, if you die within 7 years of the gift being made, you’ll be taxed up to another 20% upon your death.

    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 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 other 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 pay off some of their 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.

    Keeping a record of your gifts

    Good record keeping is important in order to reduce stress on your executors and help prove you’ve acted within the rules. This could mean you pass on more of your wealth but perhaps more importantly, it will make things a little bit easier at what’s likely to be an already difficult time.

    Could our advisers help you with IHT planning?

    A call with our advisory helpdesk is the first 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 Financial Advisers.

    Get in touch

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