Q: To minimise my estate’s inheritance tax liability, I have been making use of the £3,000 annual gift allowance, which I divide between my two sons. Can I also give them the £250 small gift allowance?
Submitted via Which? Money Magazine.
A. Inheritance tax can eat up a substantial portion of your legacy. It’s charged at 40% above a certain threshold (more on which, later) but let’s cut to the chase – how can you legally reduce a potential bill?
One of the easiest ways to do it spend your cash or give it away during your lifetime. But there are restrictions on how much you can give away tax-free.
Which? explains how gifts can help reduce your inheritance tax bill.
How much of your estate can you give as a gift?
Giving away parts of your estate – whether cash or valuable assets – is the primary way you can shrink your estate. This can help you bring down your heir’s tax bill, or even bring your estate under the tax-free threshold.
There are some crucial rules to follow in terms of giving gifts.
You can give away a maximum of £3,000 tax-free in each tax year, completely free of inheritance tax. You can also give as many gifts as you like of up to £250 – but they can’t go to the same recipients.
So if you’ve already given your two sons £1,500 each and used up your £3,000 allowance, you cannot give them a £250 gift as well without potentially incurring tax.
If you don’t use your full £3,000 limit, you can carry forward the the unused part for one year.
But what happens if you want to give more away?
Find out more: inheritance tax planning and tax-free gifts – the ins and outs of giving
‘Potentially exempt transfers’ explained
After you die, any gift you made within the last seven years will be assessed to determine whether tax are payable. These gifts are known as ‘potentially exempt transfers’ or ‘PETs’.
Any PETs will be added to other taxable gifts you made in that seven year period, alongside any other chargeable transfers. This total will be added to your estate to work out your total tax bill.
If the total is less than your nil-rate band (£325,000 in 2017-2018), no tax will be payable.
If tax is due on the gift, the person who received it will need to pay – which may come as a shock to some.
If you die within seven years of giving the gift, the tax rate your heirs pay gradually reduces the closer you get to this seven-year marker, as the table below shows.
|Time period between death and making a gift||Inheritance tax rate|
|Less than three years||40%|
|Three to four years||32%|
|Four to five years||24%|
|Five to six years||16%|
|Six to seven years||8%|
|Seven or more years||0%|
When are gifts exempt from inheritance tax?
Gifts given more than seven years before your death are almost always tax-free, provided they are given to a person.
In addition, even within the seven year period, the following gifts are generally exempt from inheritance tax:
- Gifts between husbands, wives, or civil partners to one another
- Gifts to UK-established charities, national museums, universities, the National Trust and other bodies
- Gifts that are part of your normal expenditure – you’d need to show these form a pattern of regular spending and that it doesn’t affect your standard of living
- Gifts to people getting married – each parent of the couple can give up to £5,000, while relatives can give £2,500 and anyone else £1,000
- Gifts for maintenance of a husband, wife or civil partner dependent on you
- Gifts to maintain education or training for children in full-time education or under 18
Find out more: inheritance tax checklist– what you need to know
Do you need to pay inheritance tax?
Not every estate will face paying inheritance tax.
Everyone has a tax-free allowance for inheritance tax – in 2017-2018, that allowance is £325,000. It’s been at this level since 2010-2011, and is predicted to stay frozen until at least 2019.
If you’re also passing on your home to your children, and your home is worth £100,000 or more, your tax-free allowance increases to £425,000 for 2017-2018. From April 2017, the rules have changed, which may allow married couples or partners to pay less tax on their family home.
Above this threshold, your estate will be taxed at 40%.
Find out more: inheritance thresholds – who has to pay
How else can I cut down my inheritance tax bill?
Aside from giving away or spending your money, you have a few other options for cutting down the amount your estate will be taxed – including:
- Put life insurance policies under trust
- Take out an insurance policy to pay your inheritance tax bill
- Weigh up equity release
Find out more in our guide to avoiding inheritance tax.