Inheritance tax (IHT) is a reality many individuals face when passing on their wealth to loved ones.
However, it’s important to know that there are ways available to reduce the burden of this tax.
Gifting is one such strategy that can be used effectively to save on inheritance tax while providing financial support to family and friends.
In the first of a four-part blog series, we look at ways of saving inheritance tax on your estate, in this case by the relatively simple act of making lifetime gifts.
Understanding Inheritance Tax
Before delving into the intricacies of gifting, let’s briefly understand the basics of inheritance tax in the UK.
Inheritance tax is a tax levied on the estate (property, money and possessions) of a deceased person, including certain gifts made during their lifetime.
Does this apply to everyone?
In the UK, the current threshold for an individual, called the nil rate band, is £325,000.
If your spouse dies before you and does not use all of their nil rate band the excess can be transferred to your estate.
What is a Residence Nil Rate Band?
In addition there is a further threshold, known as the residence nil rate band (RNRB), which is £175,000 per person and can also be transferred if not used on the first death.
There are restrictions on claiming the RNRB which we will highlight in a future blog in this series.
So will inheritance tax apply to my estate?
Essentially if your estate is worth more than the available nil rate bands, it may be subject to IHT at a rate of 40%.
Gifting as an Inheritance Tax Planning Strategy
Gifting involves transferring assets or money from one individual to another without any consideration or expectation of receiving something in return.
By strategically gifting your assets, you can potentially reduce the value of your estate and lower your IHT liability.
Here are some key aspects to consider when utilising gifting as a tax planning strategy:
The most straightforward way to make tax-free gifts is by utilising the annual exemption.
In the UK, you can give away up to £3,000 each tax year without it being added to the value of your estate.
This exemption can also be carried forward to the following tax year if unused.
By taking advantage of this exemption, you can gradually reduce the value of your estate over time.
Small Gift Exemptions
In addition to the annual exemption, you can make small gifts of up to £250 per person per tax year without any IHT implications.
This is particularly useful for making small gestures to family and friends on special occasions such as birthdays or weddings.
Regular Gifts Out of Income
If you have surplus income, you can gift it without it being subject to IHT.
To qualify, the gift must form part of your normal expenditure, be made out of income (rather than capital), and not affect your standard of living.
This strategy allows you to pass on funds gradually while at the same time enjoying watching your loved ones benefit from your generosity.
Potentially Exempt Transfers (PETs)
Gifts made more than seven years before your death over and above those mentioned above are generally exempt from IHT.
These are known as Potentially Exempt Transfers.
If you survive for at least seven years after making a PET, it will be completely exempt from IHT, regardless of the value.
What happens if I pass away within 7 years?
However, if you pass away within seven years of making the gift, it will be considered a failed PET.
Such gifts fall back into the estate on death and are covered by the nil rate band.
What does this mean for my estate?
To the extent that they exceed the nil rate band they will be subject to taper relief if the donor survives at least three years from the date of gift.
It is important to note that taper relief only applies if there is IHT to pay on a failed PET, i.e. if the lifetime gifts exceed the available nil rate bands.
What about gifting property?
Care must be taken when you gift chargeable assets, such as property and shares, because this could give rise to capital gains tax.
Always seek professional advice before making significant gifts.
Certain types of gifts are automatically exempt from IHT, regardless of when they were made or the value involved.
These include gifts to spouses or civil partners, gifts to qualifying charities and gifts for the maintenance of dependent relatives.
By considering these exemptions, you can ensure your gifts are IHT-free.
Is Gifting a good way to reduce the Inheritance tax liability on my estate?
Gifting can be an effective and tax-efficient way to reduce your inheritance tax liability while providing financial support to loved ones during your lifetime.
Remember that for estates that will pay inheritance tax every £100 gifted away will save potentially £40 in tax!
By understanding the various exemptions and regulations surrounding gifting you can make informed decisions about how to best utilise this strategy.
However, it’s crucial to seek professional advice from a qualified tax advisor to ensure compliance with tax laws and to tailor your gifting strategy to your specific circumstances.
Getting in touch with us
If you are interested in finding out how we can help you reduce inheritance tax on your estate or that of a family member contact Jan Friend or call us on 01634 731390.
To read more about our services please see our related pages below:
Blogs related to Inheritance Tax Planning
Take a look at our other blogs on the topic of Inheritance Tax:
Death Bed Tax Planning – is it worthwhile?
Tax trap! Is your estate worth between £2 and £3 million? If so you could lose valuable allowances
The content in this blog is correct as at 17th August 2023. See terms and conditions.