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Inheritance tax planning and tax-free gifts

Find out how to give away money from your estate to reduce your inheritance tax bill, and what is a 'potentially exempt transfer'

In this article
Can I give money away to avoid inheritance tax? Who can I give money to tax-free? What is the 'annual exemption' for inheritance tax? Which gifts are tax-free?
'Potentially exempt transfers' for inheritance tax What is IHT 'taper relief'? Get a personalised answer to tax queries 

Can I give money away to avoid inheritance tax?

If you're estate is worth more than £325,000 (or £650,000 for married couples and civil partners), then it's likely some of it will pass to HMRC in inheritance tax when you pass away. One of the most straightforward ways to make sure tax isn't charged unnecessarily is to give away assets while you are still alive.

You're allowed to make some gifts without any tax being due after your death. These always include gifts to your spouse or civil partner or if you'd like to leave money to a charity after you die. 

Most of the time it also includes gifts to individuals made more than seven years before your death. 

However, if you make a gift to your children in your will to be given after you die, it's likely there will be tax to pay (although there are exceptions). 

There will also be inheritance tax due if you put your money in a trust, or if you're passing on ownership or shares in a business (although you may be able to get business relief – which is explained further on gov.uk). 

This can be a tricky area. It's worth speaking to a professional after you have read this guide to talk about your specific circumstances. 

Who can I give money to tax-free?

Gifts to your spouse or civil partner and inheritance tax

These gifts are always tax-free. This doesn't include unmarried partners.

You can find out more in our guide to inheritance tax for married couples and civil partners.

Gifts to your family or other individuals

If you wish to leave money to other family members, such as your children, it's a good idea to plan how you want to do this. 

Some gifts are best to give while you're still alive rather than leave in your will. Most gifts to people made more than seven years before your death are tax-free (they must be to people as opposed to trusts or businesses). 

These gifts are called 'potentially exempt transfers', because tax might be payable, depending on whether you survive seven years since the gift. Potentially exempt transfers are explained further below.

Another way to gift money to your children is through a mortgage deposit, but you should take independent advice before going ahead with this.  

Want to help your child onto the property ladder?

The experts at Which? Mortgage Advisers can advise on the best option for your circumstances.

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Gifts that benefit you

You can't gift someone something that you will still maintain a benefit from in your lifetime and benefit from the gifting rules. 

For example, if you give away your home but continue to live in it rent-free until your death, you'll be deemed to be the beneficial owner, and it will still be taxed as part of your estate when you pass away. 

What is the 'annual exemption' for inheritance tax?

You can give up to £3,000 in total in each tax year that you're alive.

You can carry any unused part forward one year only to the next year (so if you didn't use this allowance last year you could give away a total of £6,000). This gift is technically called your 'annual exemption'.

As a couple, that means you'll usually be able to give away £6,000, and potentially £12,000 if you didn't make any substantial gifts the year before.

Which gifts are tax-free?

 

Small gifts of less than £250

 

You can give any number of gifts up to £250 to a single recipient, but not to anyone who has already benefited from your annual exemption. 

 

Gifts from income

 

Gifts out of income may also be tax-free. This means you can give money from your salary or pension and it won't count towards your inheritance tax. The gift must be from income, so you couldn't sell assets to give away the profit without a potential future tax bill looming over the recipient. 

According to HMRC, these gifts need to form some sort of regular spending pattern. That doesn't mean you need to commit to gifting recurring large sums, but one-off amounts are unlikely to qualify. A good rule of thumb is it will likely qualify if the gift is from your current account. 

If any relatives are currently dependent on you for maintenance because of old age or infirmity, these gifts are also tax-free. This would also include an ex-husband, ex-wife or ex-civil partner. 

Gifts for the maintenance, education or training of your children aged 18 or under (including step and adopted children) are also exempt from IHT. 

 

Wedding gifts

 

Tax is not due on gifts to people getting married, as long as it's made before the wedding and the wedding does go ahead. The amount you can give depends on your relationship to the recipient: 

  • up to £5,000 from each parent of the couple
  • £2,500 from each grandparent or more remote relative
  • £2,500 from bridegroom to bride (and vice versa) and between civil partners
  • £1,000 from anyone else.

 

Donations to charities and political parties

 

You will not have to pay inheritance tax on gifts to:

  • UK-established charities
  • national museums
  • universities
  • the National Trust
  • political parties (broadly those represented in parliament with at least 2 MPs)
  • registered housing associations
  • community amateur sports clubs.

What's more, if you make gifts to charity or political parties in your will, you may qualify for a reduced IHT rate (36%, rather than the usual 40%) on your remaining estate. The charity must be registered in the UK to qualify, and the amount you leave to charity must be at least 10% of your 'net' (ie taxed) estate. 

Let's say an individual passed away with assets worth £425,000, which they left to a friend. 

If they had left nothing to charity, then £325,000 would pass on tax-free, and the remaining £100,000 would be subject to a 40% tax charge (£40,000). So the beneficiary would receive £385,000 and £40,000 would be paid in tax. 

If instead they had left £10,000 to charity (10% of the taxable estate) and the rest to the friend, then £325,000 would still pass on tax free.

The charity would receive £10,000, also tax-free.The tax charged on the remaining £90,000 would fall to 36%, leaving a £32,400 tax bill. The friend would receive £382,600. 

The friend would receive £2,400 less, but the charity receives substantially more. And the amount lost in inheritance tax falls by £7,600. 

'Potentially exempt transfers' for inheritance tax

Most gifts you make to other people during your lifetime (unless they fall into the list of tax-free gifts) are classified as ‘potentially exempt transfers’ or PETs for short.

If you survive for seven years after making the gift, no inheritance tax is due. However, if you die within this time, the gift will be added to your estate, and reassessed against other PETs you have given and your tax-free allowance. 

If the seven-year running total of PETs, chargeable gifts and your estate comes to less than the unused tax-free allowance, no tax will be due. 

However, if much of the tax-free allowance has been used up against PETs and taxable lifetime gifts, this can leave little or no allowance to be used against the rest of the estate. 

Everyone has a tax-free allowance of £325,000 on their estate before inheritance due is due. If you don't reach this threshold including the PET also, then you won't need to pay the tax. 

Find out more: inheritance tax thresholds and rates explained

What is IHT 'taper relief'?

If tax does become due on a PET, the person who received the PET will be asked to pay the tax. However, the tax may be reduced because of 'taper relief'. 

The chart below explains how taper relief can reduce tax due on PETs. 

An often overlooked part of taper relief is that it will only kick in if the amount you gift is worth more than your £325,000 allowance, so unless you're transferring huge sums, it probably won't apply. If you die within seven years of making gifts worth less than £325,000, the full 40% IHT rate could be levied on the recipient.

While taper relief may reduce tax on PETs if you die within seven years of making them, it won't reduce the tax due on your estate as a whole. 

If that seems complex, consider the following examples, all of which involve trying to pass on £600,000, partially as gifts and partially as a final estate.

 

Example one: gift below the nil-rate band

 

Anne gives away £100,000 in March 2013, and died in April 2018, leaving a £500,000 estate. 

Anne doesn't live seven years after making the gift, so it's reassessed as part of her estate. 

The £100,000 PET is deducted from her £325,000 allowance, meaning there is £225,000 still to be used against her remaining £500,000 estate. 

The remaining £275,000 is taxed at 40%, resulting in a £110,000 inheritance tax bill. 

 

Example two: gift above the nil-rate band

 

Bill gives away £400,000 in March 2013, and then passes away in April 2018, leaving a further £200,000. 

When he dies, the PET is reassessed, and his £325,000 personal allowance is used against the £400,000 gift. 

Because the gift is in excess of the allowance, and he survived for more than five years after making the gift, the taxable part of this gift incurs a tapered 16% rate, meaning a £12,000 tax bill for the recipient. 

The remaining £200,000 estate is taxed at 40%, leaving a further £80,000 inheritance tax bill. 

In total, £92,000 is paid in inheritance tax, saving £18,000 compared with the first example. 

 

Example three: gift more than seven years before death

 

Charlie gifts £400,000 in March 2010, and then passes away in April 2018, leaving a further £200,000.

When he dies, the PET is deemed successful, as it was made more than seven years before he died. The gift is exempt from inheritance tax, and there is no further inheritance tax consequence. 

What's more, the £200,000 remaining estate falls within the £325,000 allowance - so there is no tax to pay there either. 

In total, nothing is paid in inheritance tax, saving £110,000 compared with the first example. 

 

Example four: multiple gifts

 

Danielle makes multiple potentially exempt transfers, giving £200,000 in March 2013 and £200,000 in March 2015. She passes away in April 2018, leaving a final £200,000. 

The £325,000 is first offset against the first £200,000 gift, leaving £125,000 to be offset against the second £200,000 gift. 

This leaves £75,000 which is taxed at 32%, as she had lived for more than three years after making it. This generates a £24,000 tax bill, for the second recipient. 

The remaining £200,000 is taxed at 40%, resulting in another £80,000 tax charge. 

In total, IHT runs to £104,000, still saving £6,000 compared with the first example. 

Get a personalised answer to tax queries 

The Which? Money Helpline offers independent one-to-one guidance on a range of topics, including inheritance tax. 

If you're not a Which? member, and you'd like to get unlimited access to our Money Helpline experts, you can try Which? Money for two months for £1

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