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Gifting money – inheritance tax pitfalls to avoid

Giving cash or gifts to loved ones? Check the tax implications before you do.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Gifting can be a great way to give children or grandchildren a great start in life, while reducing the future value of your estate for inheritance tax purposes. But while gifts aren’t subject to income tax, there are other tax implications to consider – some gifts can be included in your estate and therefore potentially subject to inheritance tax (IHT).

Below we explain how to make gifts in the most tax-efficient way.

Gifts that aren’t subject to tax

Everyone has the following tax-free allowances for making gifts:

  1. Annual exemption – in each tax year, you can make a gift up to the annual exemption of £3,000. On top of this, any unused exemption from the previous tax year can also be used – so up to £12,000 per couple can be gifted in this way.
  2. Gifts from income – you can make regular gifts out of income which will be completely exempt from any future IHT liability. These gifts must be from your post-tax income, made habitually, and leave you with sufficient income to maintain your standard of living.
  3. Using the surplus income exemption by making regular gifts into pensions for family can be hugely effective.

    For example, £2,880 would effectively be reduced to just £1,728 after accounting for 40% inheritance tax. But if the same sum was gifted during the donor’s lifetime into a pension for a beneficiary, and the beneficiary qualified for basic-rate income tax relief, the full amount invested in the pension would be £3,600 – more than twice as much.

    This article, and the information provided, is not personal advice. If you are unsure, seek advice. Tax rules change and any benefits are dependent on individual circumstances, and there are limits on what can be paid into pensions. It’s worth noting money in a pension can usually only be accessed from age 55 (57 from 2028). Tax is a complex subject and this is a brief overview. If you are at all unsure of your position then you should seek specialist tax advice.

  4. Marriage gifts – parents and grandparents can make one-off gifts on the marriage of children or grandchildren (up to £5,000 and £2,500 respectively). If you aren’t a parent or grandparent, you can still use this exemption to gift up to £1,000.
  5. Small gifts – in each tax year you can gift up to £250 to any number of people completely, as long as they haven’t received a gift which uses another exemption.
  6. Donations to charities or political parties – gifts to these types of organisation, either during your lifetime or via your will, are exempt from inheritance tax.

Gifts that could be subject to tax

Any gifts that are not covered by one of the exemptions listed may be subject to inheritance tax if the donor dies within seven years. Inheritance tax is usually 40% on assets over £325,000, but half of this may be due at the time of the gift if it wasn’t to an individual (such as to a trust).

So, how much can be gifted to individuals without incurring an immediate inheritance tax charge? Well, in theory, there’s no limit to the value you may gift in this way, so a considerable sum (even the majority of what you own) could be passed on. If you don’t live for another seven years, the total of gifts made in excess of your nil-rate band (usually £325,000) will become taxable on a sliding scale provided you live for at least three years.

Let’s assume you give someone £500,000 in cash, the nil-rate band at the time is £325,000 and doesn’t change in the following seven years. The table below shows the tax that would be due based on the number of years you live after you’ve given the gift. The tax would be payable by the recipient of the gift.

If the gift isn’t made then its value will be inside your estate, so tax of £70,000 would be due and this would be payable by your executors. This assumes the money doesn’t grow in value. It is worth remembering that once a gift has been made the money belongs to the recipient and so there will be no IHT due on any growth on it when they die. However, if the money remains in your estate, IHT would be chargeable on any increase in its value.

Number of years survived Reduction in tax Tax due Tax saved
0-3 0% £70,000 £0
3-4 20% £56,000 £14,000
4-5 40% £42,000 £28,000
5-6 60% £28,000 £42,000
6-7 80% £14,000 £56,000
7+ 100% £0 Up to £200,000*

Scroll across to see the full table.

In this example, unless you survived seven years there would be no nil-rate band to use against your estate.

*When you make a gift it will still be considered as part of your estate for the following 7 years. However, any tax due on the gift is reduced by the taper, offering varying levels of IHT saving. Once 7 years has passed the entire gift is out of the estate potentially increasing the saving greatly.

If the gift (when added to gifts made in the previous seven years) is less than the nil-rate band then this tapering effect does not happen and the amount of nil-rate band available to use against your estate is reduced by the value of the gifts made in the seven years before your death.

Planning your gifts

Keep a record of the gifts made and, importantly, the exemptions you are claiming. This will help your executors to administer your estate.

More about IHT rules and recommended changes. Plus, download your gift record.

Find out more

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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