27th September 2020
Making gifts to your family and friends while you’re alive is a great way to reduce the value of your estate and lower the impact of inheritance tax. Estate and tax planning is a complex subject. It’s important to understand the options available to you and the best way to do this is through sound professional advice.
In this post, we’ll go through what gifts are subject to inheritance tax and how you can make lifetime gifts that are tax-free.
Giving to Your Children and Other Family Members
To ensure that what you give your children or other family members is tax-free, it’s essential that you plan when to make the gift.
As long as you live more than seven years from when you make the gift, your children or family won’t have to pay inheritance tax on your gift when you pass on. Be aware that any income made from this gift would still be subject to capital gains tax. However, if you don’t live more than seven years after making the gift, your family members may have to pay inheritance tax.
The gift is considered a potentially exempt transfer when it is first made. If you die within seven years, it becomes a chargeable transfer and is subject to inheritance tax. We’ll discuss potentially exempt transfers in more detail later in this post.
Note that married couples and civil partners are allowed to pass their estate to their spouse tax-free when they die, meaning the surviving spouse can inherit the entire estate without having to pay Inheritance Tax.
Gifting to Charity
Any cash or physical asset you leave to a qualifying charitable organization either in your will or during your lifetime is exempt from inheritance tax. This is a great option if you’re looking to give back while still maximizing the value of your estate.
Gifting to charity can also reduce your inheritance tax rate from 40% down to 36%. This lower rate only applies if the gift to charity accounts for 10% of the net estate at the time of death.
Annual Gift Allowance
While you’re alive, you have a £3,000 ‘gift allowance’ each year known as an annual exemption. This means you can give away assets or cash up to a total value of £3,000 each tax year without it being added to the value of your estate for inheritance tax purposes.
You can carry over any unused portion of the exemption to the following tax year but it can’t be carried over to a second year.
There are a variety of gifts you can make that will not be subject to inheritance tax. This includes:
Wedding gifts are free from inheritance tax provided they meet the following requirements:
- Gifts to children are worth £5,000 or less
- Gifts to grandchildren or great-grandchildren are worth £2,500 or less
- Gifts given to another relative or friend are worth £1,000 or less
Gifts That are Worth Less Than £250
You can give as many tax-free gifts up to £250 to as many people as you want. However, you cannot give tax-free gifts to anyone who has already received a gift of your whole £3,000 annual exemption.
Gifts to Help With Living Costs
Gifts used to help pay the living costs of an ex-spouse, an elderly dependent, a child under 18, or a child in full-time education might be exempt from inheritance tax.
Gifts From Your Surplus Income
If you earn a high enough income to easily maintain your standard of living, you can make gifts from your surplus disposable income. For example, you can pay into your child’s savings account or pay a life insurance premium for your spouse. These gifts must be made regularly, so you need to be able to commit to keeping up with the installments. It’s important to keep detailed records of these gifts if you plan to use this exemption as the rules are complex.
Potentially Exempt Transfers
A potentially exempt transfer (PET) enables you to make gifts of unlimited value that will become exempt from inheritance tax if you survive seven years from the time of the gift.
If you don’t live for seven years after the gift, the PET becomes a chargeable consideration and is added to the value of your estate for Inheritance Tax purposes. If the value of the estate (including the gift) is over the Inheritance Tax threshold of £325,000, then tax may be due.
To be “Potentially Exempt”, lifetime gifts must meet certain conditions and are subject to certain exceptions. The gift must be made from an individual to another individual or to a specified trust. This means that the gift cannot be made to or from a company.
Gifts that you maintain an interest in don’t qualify as a PET no matter when they are given. For example, if you continue to live for free in the house you gave your child more than 10 years ago, the house would still be considered as part of your estate for inheritance tax purposes.
The 7 Year Rule
The 7 Year Rule helps determine the rate at which inheritance tax is charged. Gifts given within three years of your death are taxed at 40%.
Gifts made between three to seven years before your death are taxed on a sliding scale known as taper relief. Below are the different tax rates, based on the years between the gift and death:
|Years between gift and death||Tax paid|
|Less than 3||40%|
|3 to 4||32%|
|4 to 5||24%|
|5 to 6||16%|
|6 to 7||8%|
|7 or more||0%|
Be aware that taper relief doesn’t reduce the value of the gift, it only reduces the tax payable.
Professional Tax and Estate Planning
Wills and trusts are an important part of planning your estate and minimizing inheritance tax. This area of law is complex and it’s always best to seek professional advice to make sure you are on the right track.
Elizabeth Middleton Solicitors has the experience to ensure that your estate is as tax-efficient as possible. Contact us today to learn how we can help you and your family plan for the future with expert estate planning, will writing, lasting power of attorney, and conveyancing services.