You can make gifts to certain people and organisations without having to pay any Inheritance Tax.
These gifts are exempt whether you make them during your life or as part of your will.
You can make exempt gifts to:
- your husband, wife or civil partner, as long as they have a permanent home in the UK
- a ‘qualifying’ charity established in the EU or another specified country
- some national institutions such as museums, universities and the National Trust
- any UK political party that has at least two members elected to the House of Commons or has 1 elected member, but the party received at least 150,000 votes
Gifts that you give to your unmarried partner, or a partner that you’re not in a registered civil partnership with, are not exempt.
Annual Allowances. You can give away gifts worth up to £3,000 in total in each tax year and these gifts will be exempt from Inheritance Tax when you die. You can carry forward any unused part of the £3,000 exemption to the following year, but if you don’t use it in that year, the carried-over exemption expires.
In addition to the annual exemption there are other exemptions for certain types of gifts. These are explained below.
Some gifts made during your lifetime are exempt from Inheritance Tax because of the type of gift or the reason for making it.
Wedding or civil partnership ceremony gifts:
These are exempt from Inheritance Tax, subject to certain limits:
- parents can each give cash or gifts worth £5,000
- grandparents and great grandparents can each give cash or gifts worth £2,500
anyone else can give cash or gifts worth £1,000
- You have to make the gift on or shortly before the date of the wedding or civil partnership ceremony. If the ceremony is called off and you still make the gift this exemption won’t apply.
- You can make small gifts up to the value of £250
You make small gifts to as many individuals as you like in any one tax year.
However, you can’t give more than £250 and claim that the first £250 is a small gift. If you give an amount greater than £250 the exemption is lost altogether.
You also can’t use your small gifts allowance together with any other exemption when giving to the same person.
Payments from surplus income
Any regular gifts you make out of your after-tax income, not including your capital, are exempt from Inheritance Tax. These gifts will only qualify if you have enough income left after making them to maintain your normal lifestyle.
- monthly or other regular payments to someone
- regular gifts for Christmas and birthdays, or wedding/civil partnership anniversaries
- regular premiums on a life insurance policy – for you or someone else
You can also make exempt maintenance payments to:
- your husband, wife or civil partner
- your ex-spouse or former civil partner
- relatives who are dependent on you because of old age or infirmity
- your children, including adopted children and step-children, who are under 18 or in full-time education
- The Seven Year Rule
Any gifts you make to individuals will be exempt from Inheritance Tax as long as you live for seven years after making the gift.
These sorts of gifts are known as ‘Potentially Exempt Transfers’ (PETs).
However if you give an asset away at any time, but keep an interest in it – for example you give your house away but continue to live in it rent-free – this gift will not be a potentially exempt transfer.
If you die within 7 years and the total value of gifts you made is less than the Inheritance Tax threshold, then the value of the gifts is added to your estate and any tax due is paid out of the estate.
However, if you die within 7 years of making a gift and the gift is valued at more than the Inheritance Tax threshold, Inheritance Tax will need to be paid on its value, either by the person receiving the gift or by the representatives of the estate.
If you die between 3 and 7 years after making a gift, and the total value of gifts that you made is over the threshold, any Inheritance Tax due on the gift is reduced on a sliding scale. This is known as ‘Taper Relief’.
Gifts into trust are not generally exempt from Inheritance Tax.
The importance of keeping good records
It will help your executor or personal representative to sort out your financial affairs when you die if you keep a record of any gifts you make and note on that record which exemption you’ve used.
It’s also a good idea to keep a record of your after-tax income if you make regular gifts out of income as part of your normal expenditure. This will show that the gifts are regular and that you have enough income to cover them and your usual day-to-day expenditure without having to draw on your capital.
Used systematically these allowances can make a real difference to those you ultimately wish to benefit. If a couple each only use their annual allowance for nine years they will be able to remove £60,000 out of their combined estate legitimately avoiding £24,000 of Inheritance Tax – not a bad return for writing 18 cheques!
If you have surplus income, then gifts that are made regularly from this, supported by clear records to evidence that the income was indeed surplus are a great way to remove money from your estate and certain IHT.
What about this idea?
If you have very significant Inheritance Tax (IHT) issues you could consider gifting your home to your son and then pay him a full market rental from your surplus income in order to continue living in it.
If the property was worth £300,000 and the full market rental was £800 per month then after 7 years the property falls out of your estate for IHT purposes and the rent (7x12x800 = £67,200) is also out of your estate avoiding a further £26,880 of IHT.
The total IHT saving available is £367,200 x 40% = £146,880. Of course if the property increased substantially in value your son would be liable to pay Capital Gains Tax (CGT) on the increase (CGT relief is only available on your principal private residence).
Let’s assume that the property doubles in value over 7 years.
Firstly this increase would have caused a further IHT bill of £300,000 x 40% = £120,000 making the total cost of doing nothing £120,000 plus the earlier figure of £146,880 = £266,880.
Alternatively the CGT bill would be payable on the £300,000 gain, less £11,000 personal annual CGT allowance and any costs incurred in maintaining and improving and selling the property – let’s say £19,000 to make the maths easy = giving a taxable gain of £270,000 x 28% = CGT of £75,600.
In this scenario your son would be £191,280 better off. If the property had increased to £1,200,000 in value the result of the “do nothing” approach is a £1,200,000 property taxed at 40% = IHT of £480,000 plus IHT on the rent of £67,200 (£26,880) = a total tax bill of £506,880 or alternatively 28% CGT on the increased capital value of £870,000 (after annual allowance and costs) = £243,600.
A saving of £263,280
This is just one option that these clients could have considered.
How to decide what is best for you
Before embarking on any course of action it is essential to consider the full circumstances and objectives of each client. We do not recommend particular actions without carefully looking at all of the circumstances, all of the objectives and all of the options.
A thorough appraisal is needed
If you would like us to do this for you – please don’t hesitate to contact us.