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5 inheritance tax rules to know when gifting money this Christmas
Cash can be a welcome present, but your generosity could leave loved ones with a tax nightmare later on
Christmas is a time for giving and, although not the most imaginative, the gift of money tends to go down well with friends and family.
However, when you're gifting cash, you'll have to keep HMRC in the back of your mind as you could risk your family facing an Inheritance Tax (IHT) charge when you die.
That said, there are certain IHT rules you can use this Christmas to pass on money completely tax-free.
Here, Which? explains how HMRC finds out about festive cash gifts, and shares the five IHT tax rules you should know when giving loved ones money this year.
How will HMRC know about your gifts?
Let’s say you pulled out £3,000 from your account and gave it to your niece to give her a bit of help to buy a new car.
If you don’t tell HMRC, how will it know? Well, it won’t. Not immediately, that is, as there's no legal requirement to report this gift at the time it's made.
The primary way HMRC learns about gifts is during the probate process after your death.
The executor of your will — or administrator of your estate — is legally required to complete IHT forms, which ask for details of gifts made in the seven years before death.
The executor will examine your financial records, bank statements, and personal papers to identify any significant gifts. If they see a large cash withdrawal or bank transfer without an obvious explanation, they will likely record it as a gift to be included in the IHT calculation.
The executor is personally responsible for ensuring the IHT forms are accurate and complete. If they fail to disclose any gifts, then this can potentially result in penalties for the estate.
- Find out more: inheritance tax planning and tax-free gifts
5 ways to avoid IHT on Christmas money gifts
By taking advantage of all the gifting rules for IHT, you can make sure you don't leave your family with a shock tax bill after you've gone.
1. Use your annual exemption
Every tax year, you can give away up to £3,000 in total — in cash or gifts — without any IHT to worry about. This is the annual gifting allowance. You can give this entire amount to one person or divide it among several different people.
Don’t worry if you don’t make full use of your allowance over the year, as anything unused can be rolled over into the new tax year – but only for one year.
This means that you could give up to £6,000 across two tax years without your loved ones facing an IHT charge.
- Find out more: inheritance tax calculator
2. Make small gifts
There is a separate Small Gift Exemption allowing you to give gifts worth up to £250 to any number of people each year — and these gifts will not affect your £3,000 annual allowance.
However, if you use any other tax allowance to give a gift to a specific person, you cannot also claim the small gift exemption for them in the same year.
'Use a Junior Isa if gifting money to children'
Parents and grandparents can use a Junior Isas (Jisas) if they are gifting money to loved ones under the age of 18. Jisas are tax-free savings accounts for children, which means the child won’t need to pay any tax on any interest or returns they gain.
For the current tax year, the yearly savings limit for a Jisa is £9,000. This means that, even if more than one person is contributing to the same one, you could use all of your inheritance tax exemption allowance of £3,000 and there would still be £6,000 that other people can put in.
Deputy Money Editor Sam Richardson says: ‘If giving money to children for when they’re older, get the right type of Junior Isa.
'While losses are possible, an investment junior Isa could multiply the money they receive several times over, entirely tax-free.
'Plus, they will have many years to ride out market shocks. It becomes a stocks and shares Isa when they reach 18. Only a child’s parents can set up a junior Isa for them, but once it’s open, anyone can pay into it.'
- Find out more: best Junior cash Isas and best investment Jisas
3. Take advantage of the wedding exemption
If you've been invited to a Christmas wedding and want to give a cash gift, there is a wedding exemption that you can use to avoid a tax headache.
Under IHT rules, for weddings, you can give:
- £5,000 to your children
- £2,500 to your grandchildren
- £1,000 to anyone else.
You can also combine the wedding gift allowance with any other allowances — except for the small gift allowance. For example, you could combine the £2,500 wedding allowance for a grandchild with your £3,000 annual allowance to give a total of £5,500 tax-free.
- Find out more: 7 things to know about inheritance tax changes and your pension.
4. Understand the 'secret' surplus income rule
Another little-known and powerful IHT tip is the so-called 'gifts from surplus income' exemption, and not many people are aware of it. According to a Telegraph freedom of information request, it was only used by 430 people in 2022.
Under the rule, you can make regular payments to someone to help financially support them if it's part of your normal expenditure. There’s no set cap here on how much you can give, and to qualify for this exemption, you must ensure that the payments are made from your income and not from your savings.
You must also establish an accurate and clear pattern of payments, and finally, it cannot negatively impact your standard of living.
So instead of giving one larger payment, why not spread it out over the year/s, as it could cut down your IHT bill significantly. According to Fidelity, a couple each giving £5,000 every year for seven years could potentially give gifts totalling £70,000 and save £28,000 in IHT.
- Find out more: do you pay inheritance tax on premium bonds?
5. Plan when you make the gift
Even if your Christmas gift exceeds the standard tax-free allowances, it may still avoid an IHT bill thanks to the seven-year rule. A large gift is initially known as a Potentially Exempt Transfer (PET) because the IHT charge only applies if you die within seven years of making it.
So, if you survive the full seven years, the gift becomes completely exempt from IHT. If you die sooner, however, your beneficiaries will be taxed on the gift using a sliding scale, known as Taper Relief.
The principle is simple – the longer the period between giving the gift and your death, the lower the IHT charge will be:
- 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%
- More than seven years: 0%
Make sure you keep records
When making financial gifts — no matter how big or small — it’s important to keep accurate records, even if it was just a Christmas one-off.
You'll need to make a note of exactly what was gifted, for example, money, property, jewellery, or shares, and the value of the gift at the time. You can keep your records in whatever format you prefer, whether that’s a notebook, spreadsheet or digital file. You should then update your records every time you gift money to someone.
After your death, your executors (the people handling your estate) are responsible for reporting all gifts on the IHT400 form, especially any you made in the seven years before you died.
Make sure you store your records safely and make sure your executors know exactly where to find them. This step saves your family time, stress, and potential tax trouble later on.
