How to reduce inheritance tax (IHT) on financial gifts
Financial gifts can make a huge difference for children and grandchildren but care needs to be taken to ensure they are carried out tax efficiently.
Lifetime gifting could include making cash gifts from surplus income, charitable giving and taking advantage of annual exemptions and the small gifts exemption.
Currently no IHT is due on the first £325,000 of any estate, rising to £500,000 if a property is being left to a direct descendant for estates under £2m. Married couples and civil partners can leave up to £1m tax-free.
Gifting to children or grandchildren could be a tax-efficient way to help to improve their financial security, help them pay university tuition fees, pay off student loans or even get them on the property ladder. Such gifting, if structured correctly, could also serve as steps towards reducing the IHT exposure across an individual’s estate.
The latest IHT figures for April to August this year showed £3.2bn was collected with a record £795m paid in June this year. IHT receipts are expected to keep climbing and are forecast to reach £8.4bn by the 2027/28 tax year due to a combination of rising wealth and a freeze in IHT thresholds at their 2020/21 levels until 2027/28.
Examples of tax-efficient lifetime gifting include:
- Regular gifting out of surplus income. There needs to be a pattern of gifting so that this forms part of the donor’s regular expenditure and the gift needs to be out of surplus income, not capital, and must not affect the donor’s standard of living. This could be useful for individuals with significant pension income as well as those with rental and investment income. A clear record needs to be maintained of both the gifts made plus the donor’s income & expenditure for each relevant year. Such qualifying gifts are immediately outside of the donor’s estate.
- Annual exemption. The exemption allows £3,000 to be given away per tax year without being added to the value of an estate and can be carried forward for a year meaning individuals can give £6,000 and couples £12,000 if they have not used the exemption previously.
- Small gifts exemption. The small gift exemption is £250 per tax year with no limit on the number of people it can be given to.
- Gifts in consideration of marriage or registration of a civil partnership. The exemption here is £5,000 if the donor is a parent of one party to the marriage/civil partnership, £2,500 where the donor is a remoter ancestor of a party to the marriage/civil partnership and £1,000 in regard to any other donor.
- Potentially exempt transfers (outright gifts). If a cash gift is not immediately exempt, it will most likely be a potentially exempt transfer (PET) for IHT purposes. With a PET, if the individual who made the gift survives 7 clear years after making the gift, the value transferred will be exempt from IHT, regardless of the value. This is as long as the donor has no future control or benefit over the gift (‘gift with reservation of benefit’ or ‘pre-owned assets tax’).
- Chargeable lifetime transfers (trust tax planning). An individual with assets at their disposal may be prepared to make absolute gifts of those assets to relatives or friends, as steps towards IHT planning. Whilst a direct gift has the benefits of simplicity, there are a number of reasons why an individual may not wish to make outright gifts, such as loss of control and the age or personal circumstances of the donee. By gifting assets to a trust rather than to an individual outright, a donor is able to remove assets from their estate, thereby triggering the ‘7-year clock’ for IHT purposes (discussed above) but is able to avoid some of the disadvantages associated with an outright gift but retain an element of control.
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