Financial Gifts and Inheritance Tax

A key part of estate planning is the transferring of wealth while you’re alive to family or beneficiaries using tax-efficient gifts or placing assets into trust. In this article, I will explore financial gifts, and how they can reduce your Inheritance Tax bill.

What is Inheritance Tax?

Inheritance tax, sometimes written as ‘IHT’, is a charge (tax) on death, on the value of an individual’s estate as at the date of their death, over and above a certain allowance called the ‘nil rate band’. You must pay inheritance tax at a rate of 40% on anything above the nil rate band allowance. The standard nil rate band allowance is £325,000.00 per individual. This means that the tax is only charged on the part of the estate that is above this threshold.

Example

Your estate is worth £500,000.00. The tax-free threshold is £325,000.00. The inheritance tax charged will be 40% of the difference, which is £175,000.00. In this scenario, the tax bill would equal £70,000.00.

Any unused amount within the threshold can be passed onto a surviving spouse or civil partner (transferable nil rate band). This can potentially bring their nil rate band up to £650,000.00.

Residence Nil-Rate Band

In addition to the nil rate band, there are a number of exemptions, allowances, and reliefs that may further reduce the amount of IHT payable.

The residence nil rate band is an extra nil rate band for married couples or civil partners when their estate includes a property that is being left to their children or other direct descendants.

The current level for residence nil-rate band sits at £175,000.00. As any unused amount within the threshold can be passed onto a surviving spouse or civil partner also, the combined inheritance tax nil rate band could be up to £1 million if conditions are met.

Minimising the Inheritance Tax bill

The 7-year rule

No tax is due on any gifts you give if you live for 7 years after giving them - unless the gift is part of a trust. This is known as the 7-year rule, or ‘Potentially Exempt Transfers’ (PETs).

If you fail to survive for seven years, the gift becomes chargeable and could use up all or part of your nil rate band. However, the longer you survive after making the gift (subject to surviving at least three years), the lower the IHT. This relief is called ‘taper relief’ and will be calculated as follows:

Taper relief only applies if the total value of gifts made in the 7 years before you die is over the £325,000.00 tax-free threshold.

Example

Jack died on 1 January 2023. He was not married or in a civil partnership when he died. He gave 3 gifts in the 9 years before he died:

1. £40,000.00 to his brother 9 years before his death.
2. £325,000.00 to his sister 4 years before his death.
3. £120,000.00 to his friend 3 years before his death.

There’s no Inheritance Tax to pay on the £40,000 gift to his brother as it was given more than 7 years before he died.

There’s also no Inheritance Tax to pay on the £325,000.00 he gave to his sister, as this is within the Inheritance Tax threshold.

But his friend must pay Inheritance Tax on their £120,000.00 gift at a rate of 32%, as it’s above the tax-free threshold and was given 3 years before Jack died. The Inheritance Tax due therefore is £38,400.00.

Jack’s remaining estate was valued at £400,000.00, so the estate would pay Inheritance Tax of 40% on £400,000.00 (£160,000.00).

Gift with reservation

If you give something away but still benefit from it (a ‘gift with reservation’), it will continue to count towards the value of your estate.

Gifts with reservation include:

• Giving your home to a relative but still living there.
• Giving away a caravan but still using it for free for your holidays.
• Giving away a valuable painting but still displaying it in your house.

Certain gifts are exempt from Inheritance Tax

Spouses and Civil Partners

There’s no Inheritance Tax to pay on gifts between spouses or civil partners. You can give them as much as you like during your lifetime provided that they:

1. Live in the UK permanently.
2. Are legally married or in a civil partnership with you.

Charities or Political Parties

There is no Inheritance Tax to pay on any gifts you give to charities or political parties.

Annual Exemption

You can give away a total of £3,000.00 worth of gifts each tax year without them being added to the value of your estate. This is known as your ‘annual exemption’.

You can carry any unused annual exemption forward to the next tax year - but only for one tax year (£6,000.00).

Small Gift Allowance

You can give as many gifts of up to £250.00 per person as you want each tax year, as long as you have not used another allowance on the same person.

Birthday or Christmas gifts you give from your regular income are exempt from Inheritance Tax.

Gifts for weddings or civil partnerships

Each tax year, you can give a tax-free gift to someone who is getting married or starting a civil partnership. You can give up to:

• £5,000.00 to a child.
• £2,500.00 to a grandchild or great-grandchild.
• £1,000.00 to any other person.

If you’re giving gifts to the same person, you can combine a wedding gift allowance with any other allowance, except for the small gift allowance. For example, you can give your child a wedding gift of £5,000.00 as well as £3,000.00 using your annual exemption in the same tax year.

If you make regular payments

You can make regular payments to another person, for example to help with their living costs. There’s no limit to how much you can give tax free provided that:

• You can afford the payments after meeting your usual living costs.
• You pay from your regular monthly income.

These are known as ‘normal expenditure out of income’. They can include:

• Paying rent for your child.
• Paying into a savings account for a child under 18.
• Giving financial support to an elderly relative.

If you’re giving gifts to the same person, you can combine ‘normal expenditure out of income’ with any other allowance, except for the small gift allowance. For example, you can give your child a regular payment of £60.00 a month (a total of £720.00 a year) as well as using your annual exemption of £3,000.00 in the same tax year.

If you require any advice in relation to any of the information outlined above, please telephone or email our Inheritance Protection team on 02392 660261 or Info@biscoes-law.co.uk

This article is intended for general information purposes only and does not constitute legal or professional advice. This is a notoriously complex area of law and advice should be sought before proceeding with any transfers to avoid any potential pitfalls.

Author - Tom Courch, Solicitor, tcouch@biscoes-law.co.uk