Inheritance Tax Gifts Explained
Giving away money during your lifetime can help reduce inheritance tax on your estate, provided you follow the rules. Here’s how to make use of tax-free gifts and maximise the inheritance you can pass on to your loved ones.
Giving gifts in your lifetime can reduce the value of your estate and help minimise how much inheritance tax is due when you pass away. You may also want to see your family benefit from their inheritance early, while you’re still around.
There are strict guidelines you need to follow if you want to make lifetime gifts part of your estate plan. The amount you are gifting, who you’re making the gift to, and when you do it are crucial factors. There are also exemptions, such as when you give money to a charity, your spouse or civil partner.
It’s a complicated area, which is why financial advice is a must. But if you don’t know your PETs from your taper relief, this article offers a useful introduction to using inheritance tax gifts.
How can gifts help reduce inheritance tax?
Inheritance tax (IHT) is a tax on the estate of someone who has died. While most people in the UK don’t have to pay IHT, for those who do, it can be costly.
To keep the value of an estate below the tax threshold when you die, or not too far above it, it’s possible to give away money and other assets in your lifetime, provided you follow the rules.
Here’s how the thresholds work:
- If you pass on an estate worth less than the IHT threshold of £325,000, called the nil-rate band, there will be no IHT to pay. If your estate is worth more than £325,000, the amount above this will be liable for 40% IHT.
- If property is part of your estate and you leave it to your children or grandchildren, you can add £175,000 to that allowance, known as the residence nil-rate band. This means you would have a £500,000 allowance in total.
- Not counting property, married couples and civil partners can pass on £650,000 combined, or up to £1 million including the property allowance, when one partner passes away.
- If an estate is worth more than £2 million, for every £2 above that, the residence nil-rate band allowance decreases by £1.
If your estate is likely to exceed these allowances when you die, it stands to reason that passing on your wealth early might appeal as a way to help reduce your IHT bill.
» MORE: How inheritance tax works
What are inheritance tax gifts?
A gift is an asset you give away that would otherwise be counted as part of your estate. It’s something that has value, which could be money, property, land or belongings. It should be an outright gift you won’t get any benefit from.
It’s also a gift if you sell something of value to a relative, such as a house, for less than it is worth. So if you sell your semi-detached house to your son for £260,000 but its market value is £300,000, the difference of £40,000 would be considered a gift.
If you give a gift that you will still benefit from or are using, it’s called a gift with a reservation of benefit. This might be if you are living in a home you’ve given away to your daughter but aren’t paying rent, or even antique furniture you use in your home that you’ve gifted to someone else. You aren’t giving it away completely, so it would be considered part of your estate and liable for IHT.
Who can you gift to, tax free?
There are specific people and institutions that you can gift to tax free in your lifetime or after you’ve passed away, as set out in your will.
IHT gifts between spouses and civil partners
These gifts won’t count towards an IHT allowance, provided you and your spouse or civil partner are permanent UK residents. There is no limit on the amount you can transfer to each other. If shares or a home are gifted, capital gains tax may be due, though.
However, the exemption for couples doesn’t apply if you and your partner aren’t married or in a civil partnership. This means gifts above the threshold may be liable for IHT.
IHT gifts to charities and other institutions
There is usually no IHT to pay if you pass a gift to a charity, political party, community sports club or some national institutions, such as museums.
If you leave at least 10% of the net value of your estate to an eligible charity in your will, you will pay a reduced rate of IHT – 36% rather than 40% – on the rest of your estate, if IHT is payable.
Tax-free gift allowances
There are other exemptions for gifts that are worth being aware of.
In your lifetime, you have an annual gift allowance of £3,000. This can be to one person or split among a few people. This means you can give away a total of £3,000 to anyone tax free, each year, and it won’t be included in the value of your estate.
If you don’t give away that amount in a year, you can carry the unused allowance over and add it to the next year’s allowance. The allowance can’t be carried over beyond that, though.
Other types of gifts that aren’t liable for IHT include:
- Wedding and civil partnership gifts: These must be given before the ceremony and how much you can give IHT-free depends on your relationship with them. The maximum amount you can give ranges from £1,000 for a relative or friend to £5,000 for your child.
- Small gifts up to £250: This amount can be transferred to as many people as you want each tax year, as long as they haven't already benefited from your £3,000 annual exemption. Birthday and Christmas gifts you buy with your regular income aren’t subject to IHT, either.
- Surplus income: This is money from your income that is more than you need to maintain your standard of living and must be paid regularly, such as payments into a savings account for your child.
You may also be able to give gifts to help someone with living costs, such as to an older person who is dependent on you.
Tax on gifts and the seven-year IHT rule
Gifts that don’t fit the exemptions above will usually be classified as a potentially exempt transfer (PET). There is a seven-year IHT rule in relation to these. This is to prevent people giving away money just before they pass away to avoid paying IHT.
If you die within seven years of making a PET it becomes a chargeable transfer, and will be considered part of your estate and taken into account for the IHT calculation. If you survive for at least seven years after you’ve given a gift it won’t be part of your estate or considered for IHT – regardless of the value of the gift.
If the gift-giving happens within seven years before you die, the amount of IHT to pay depends on when you gave the gift away and its value.
If you die within three years of giving the gift, 40% IHT will be charged on any amount above the tax-free threshold for your estate. If you gave the gift earlier than that, there is a sliding scale, called taper relief:
The seven-year IHT rule also applies if you gift money towards a mortgage deposit, perhaps to help a first-time buyer in the family – unless it falls within your £3,000 annual gift allowance.
Who pays IHT on gifts?
If the combined value of your estate and gifts given in the seven years before you die is over the nil-rate band, IHT will usually be paid from your estate after you have died.
However, if you give away more than £325,000 worth of gifts in the seven years before you die, the recipient of any further gifts in your lifetime will pay IHT on their gift.
For example, say someone gave these gifts in their lifetime:
- £100,000, 10 years before their death: there would be no IHT to pay, as they died more than seven years later.
- £325,000, three years before their death: there would be no IHT to pay, as though it was given within seven years of their death, it doesn’t exceed the nil-rate band.
- £50,000, two years before their death: the recipient would need to pay IHT at a rate of 40% on their gift (£20,000), as the person making the gift has exceeded their allowance.
If the tax-free allowance has been used up by the gifts, the rest of the estate may be taxed at 40% IHT.
If the total value of gifts in seven years before someone’s death is under the threshold of £325,000, the remaining allowance would be used against the rest of the estate.
Keep a record of gifts and get expert advice
You’ve probably realised by now that making sure you follow the IHT rules is essential if you want to avoid a potentially hefty tax bill for your estate and your loved ones.
After your death, your executor will need to know about any gifts you gave away in your lifetime. Make a note of who you made a gift to and when, along with the value and nature of the gift. This will help them work out the amount of IHT, if any, which is due from your estate.
If your estate is likely to stay well within the IHT threshold, you may not need to consider gifts at all. But if you think gifts might be a useful way to pass on as much inheritance as possible, an estate planning solicitor or financial adviser can help you get it right.
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Holly champions clear, jargon-free writing. She’s been creating finance content for leading organisations for over 10 years. Read more