Making gifts is one of the easiest ways to reduce inheritance tax on your estate. Historically, it has been the practice for one generation to leave assets to the next generation on their death.
Times have changed because we are all living longer and it makes a good deal of sense to pass wealth down the generations while we are still living.
By making gifts to children, grandchildren, charities and others during your lifetime it will not only reduce the value of your estate for inheritance tax purposes but more importantly it will enable you to see the benefit of your generosity while you are still alive.
In many cases you can benefit directly from this such as when you might enable one of your children to purchase a better property than they would otherwise be able to do. After all, are you not going to be visiting them and enjoying the better property.
The Annual Exempt Amount
The Annual Exempt Amount – the first £3,000 of gifts that you make in any tax year is free of IHT. This exemption may also be used to cover part of a larger gift. Each spouse has a separate annual exemption. Any unused balance may be used in the following tax year but only after the exempt amount for that second tax year has been used up.
Mr and Mrs Alan wish to help their daughter by giving her £50,000 towards the purchase of her first house. They have made no previous large gifts to anyone.
The first £3,000 of Mr Alan’s share of the gift is free of IHT and so is a further £3,000 being the unused exempt amount for the previous tax year. Mrs Alan is in the same situation and therefore the first £12,000 of their joint gift is free of IHT. The balance of £38,000 is treated as a PET (Potentially Exempt Transfer) and will only be brought into their estate if they die within the next 7 years.
Small Gifts – gifts you make which do not exceed £250 to any one recipient in any tax year are classed as ‘small gifts’ and are tax free. There is no limit on the number of such small gifts which you can make tax free. However, where your gifts to an individual exceed £250, the exemption is lost completely. You cannot combine this exemption with any other exemption to cover a larger gift.
OTS (Office of Tax Simplification) recommendation is to reconsider the level of the small gifts exemption
Gifts made out of income
Gifts made out of income – your gift should be normal, i.e. that you had a habit of making such gifts and that they have left you with sufficient income to maintain your normal standard of living. Regular amounts such as the payment of premiums on a life assurance policy qualify if you pay them from income. Surplus income from a deposit account is acceptable.
OTS recommendation is to reform the exemption for normal expenditure out of income or replace it with a higher personal gift allowance
Gifts in consideration of marriage
Gifts in consideration of marriage – gifts made to the bride or groom in consideration of their marriage (or civil partnership), are exempt up to the following amounts:
- £5,000 from you as a parent of the bride or groom
- £2,500 from you as a grandparent of the bride or groom
- £1,000 from you as other than the above
You may make gifts to either party of the marriage, not just your own child or grandchild but the gifts should be made conditional upon the marriage taking place.
Mr and Mrs Baldwin also wish to help their daughter by giving her £50,000 towards the purchase of her first house. They have made no previous large gifts to anyone. In this case, however, their daughter is getting married in a few months’ time.
We have seen from the previous example that the first £12,000 is free of IHT. Of the balance of £38,000, Mr and Mrs Baldwin each give £5,000 to their daughter in consideration of the marriage. They also each give £5,000 to their future son-in-law in consideration of the marriage. In this way they are able to give a total of £32,000 (ie £12,000 + £20,000) which is exempt from IHT. The much smaller balance of £18,000 is treated as a Potentially Exempt Transfer (PET) and will only be brought into their estate if they die within the next 7 years.
Gifts to Charities and Registered Clubs
Gifts to Charities and Registered Clubs – which are established in the UK (or the EU presently) are tax free regardless of the amount. A reduced rate of IHT (i.e. 36%) applies for deaths where 10% or more of a deceased’s net estate (after the deduction of all IHT exemptions, reliefs and the nil rate band) is left to charity.
Mrs Cooper, a widow, has been shown that her net estate would currently be £500,000 and her children would need to pay 40% IHT on this (£200,000). Her children have long supported the World Wildlife Fund as they are very interested in conservation and assisting endangered species.
They all agree that it would be a good idea if Mrs Cooper would leave £60,000 to the WWF. This will not only reduce her net estate to £440,000 but the tax rate would reduce to 36% meaning a reduced IHT bill of £158,400. In effect the £60,000 gift to the WWF has cost them just £18,400 (i.e. £200,000 – £158,400 = £41,600)
Gifts for national purposes
Gifts for national purposes – gifts to certain national bodies are exempt from IHT. These include colleges and universities, the National Trust, the National Gallery, the British Museum and other galleries and museums run by local authorities and universities.
Gifts to political parties
Gifts to political parties – gifts to ‘qualifying political parties’ are exempt. A political party qualifies if it had at least two MPs returned at the last general election, or it had at least one MP and more than 150,000 votes were cast for its candidates.
Special Relief – the taxable value of certain classes of business and agricultural property may qualify for a 50% or even 100% relief depending on the type of property being transferred.
Potentially Exempt Transfers
Irrevocable gifts that you make during your lifetime, if not covered by any exemption, are usually classed as potentially exempt transfers (PETs). This includes gifts that you make into ‘bare’ trusts.
Seven Year Rule
Seven year rule – if you make a PET and survive for seven years after making the gift it becomes an exempt gift and no IHT is due.
PETs are not subject to IHT at the time that you make them but they become chargeable transfers if you die within seven years. Usually it is the estate which is liable for IHT. However if you are the recipient of a gift, and the giver has died within seven years, and has already given away more than £325,000, you could be liable to pay IHT yourself.
Reservation of Benefit
Reservation of benefit – if you make a gift that is subject to a ‘reservation of benefit’ it cannot be a PET. This is where you make a gift but continue to gain some benefit from it, Such a gift is still considered to be part of your estate for IHT purposes.
Mrs Davies is a widow, age 80, living in a house worth £1 million. Her other assets are around £600,000. Her children have suggested that she transfer the house into their names, but continue to live there for the rest of her life, as she is likely to live for a further seven years and IHT will then be avoided on her estate.
However, the house would still be considered as part of her estate for IHT purposes as Mrs Davies would retain a reservation of benefit. It might be possible to avoid this situation if the children can demonstrate to HMRC that their mother paid a proper market rent for the property from the date of the transfer until her death. At thousands of pounds a month this might not be a practical solution.
Taper Relief – where you make a PET and die within seven years, ‘taper relief’ may reduce the amount of IHT payable. This is a sliding scale, which reduces the tax the more of the seven years that you live as follows:
Taper relief cannot reduce the tax on a lifetime chargeable transfer below the nil rate band. Therefore, whether taper relief will actually reduce the IHT depends on whether the particular gift, in addition to other PETs made during the seven years prior to death, is in excess of the nil rate band.
OTS recommendation is to abolish taper relief
Transfers – the legislation refers mainly to transfers rather than to gifts. The reason for this is that all gifts are transfers of value, but not all transfers of value are gifts.
Chargeable transfers are all other transfers of value which you make during your lifetime, and which are not either exempt or treated as a PET. A chargeable transfer can give rise to an immediate IHT liability.
Mr and Mrs Edwards own a two bedroom flat on the seafront at Brighton recently valued at £600,000. They decide to sell it to their two daughters for £100,000.
Mr and Mrs Edwards may not be making a gift but they are certainly making a transfer of value.
Lifetime IHT rate is 20% – the liability under a chargeable transfer is to lifetime IHT which is charged at one half of the death rate of 40%. However, this will only be charged if, when added to all other chargeable transfers within the last 7 years it exceeds the nil rate band.
As with PETs, such chargeable transfers are also included in your estate should you die within seven years so that, if necessary, the balance of the 40% tax can be paid.
OTS recommendation is to explore options for simplifying and clarifying the rules on liability for the payment of tax on lifetime gifts to individuals and the allocation of the nil rate band.
14 Year Rule
14 year rule – If a donor dies within seven years of making a PET, that gift becomes chargeable. The IHT rules then state that any other chargeable transfers made in the seven years prior to date of the ‘failed’ PET must be taken into account to determine how much of the nil rate band has been used up by these gifts.
In May 2010 Mr Flowers placed £250,000 into a discretionary trust (chargeable lifetime transfer) and in April 2016 he gave £150,000 to his daughter (PET) to enable her to move to a better property. Mr F died in March 2022.
There would have been no IHT payable in Mr Flower’s lifetime as the £250,000 chargeable gift to the trust was within the Nil Rate Band and the gift to his daughter of £150,000 was a PET.
However, on death the story is different. The gift to his daughter has become chargeable as Mr Flowers died within seven years. Any other chargeable transfers in the seven years prior to the failed PET now need to be taken into account to calculate how much Nil Rate Band is available.
As the 2010 gift to trust was less than seven years before the gift to his daughter, it uses up £250,000 of the Nil Rate Band. There is only £75,000 of the £325,000 Nil Rate Band remaining to set against the £150,000 gift to his daughter so £75,000 of this gift is now chargeable to IHT. In this instance, the £250,000 gift to the discretionary trust has resulted in an IHT charge on death nearly 12 years later.
OTS recommendation is to remove the need to take account of gifts made outside of the 7 years period under the 14 year rule
How a transfer is measured
The amount of any transfer is determined by the reduction in value of your wealth. This is not necessarily the same as the increase in the recipient’s wealth.
Mr Glover owns 51% of the shares in his company. His daughter works in the company and together with his son they own 49%. Mr Glover has control because he has the majority of the shares. He decides to give a further 2% shareholding to his daughter as she is destined to run the company when he retires.
The 2% shareholding given to his daughter might not be worth very much in isolation, and his daughter might not have acquired a very valuable asset. However, Mr Glover has relinquished control of the company and his estate would have decreased in value by the difference between the value of a 51% shareholding and that of a 49% shareholding, which could be a substantial amount.
Links to more information
- Inheritance tax
- Unsure about Inheritance Tax
- How to calculate Inheritance Tax
- The family home in Inheritance Tax planning
- Ways to reduce Inheritance Tax
- Will and Lasting Power of Attorney
- HMRC notes on Inheritance Tax
- If you need personal financial advice on Inheritance Tax then I am happy to introduce you to Flying Colours Life who have access to independent financial advisers throughout the UK
This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.
Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.
If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.