After a year of record Inheritance Tax (IHT) receipts, it’s understandable that you might want to look for methods that can mitigate the 40% bill your family may be liable for when you pass away.
Indeed, according to HMRC’s latest update released in December 2022, IHT receipts in 2021/22 reached a record-high £6.1 billion.
IHT comes into effect on estates that exceed the nil-rate band (NRB), a tax-free threshold standing at £325,000 in the 2022/23 tax year. You may also be able to make use of the additional nil-rate band (RNRB) of £175,000 if you pass your main residence to your direct descendants.
That means you can pass on up to £500,000 tax-free on your death, or up to £1 million if you are married or in a civil partnership.
However, any value over these amounts may be subject to IHT, underlining the importance of finding ways to reduce the size of your estate.
In particular, gifting assets can be a powerful tool for doing so, moving you below the tax-free thresholds while simultaneously putting your money into the hands of those you’d most like to have it without having to pay a 40% IHT charge.
So, read about the various gifting rules and exemptions that could help mitigate the tax charge your beneficiaries might be facing.
Remember: the key to making gifts successfully is in keeping accurate records that show who you made gifts to, when, and for how much. That way, your executors will be able to accurately calculate the size of your estate on your death.
Using your tax-free annual gifting exemption
First and foremost, you may want to consider making use of your gifting “annual exemption”. This allows you to gift a certain amount each tax year, with the sum falling outside your estate.
In the 2022/23 tax year, the exempt amount is £3,000. You can carry forward one year’s worth of unused allowance, meaning you can individually gift up to £6,000 in a single tax year provided that you haven’t used any of your exemption from the current and previous tax year.
Additionally, you can combine your exemption with your spouse or civil partner, taking your maximum exemption up to £6,000 in a single tax year, or £12,000 if both of you carry forward a full year of unused exemption from the previous tax year.
While the annual exemption is not a huge figure itself, making use of it each tax year could make a significant difference to your IHT liability – indeed, if you and your spouse or civil partner made full use of your exemptions for 10 years, you could gift up to £60,000 that would not count towards the value of your estate.
You can make tax-free gifts to people getting married
In addition to the gifting exemption, you can make financial gifts to people getting married, with these gifts also falling outside of your estate.
The size of the tax-free gift you can make depends on how you know the bride or groom. In the 2022/23 tax year, you can make gifts of up to:
- £5,000 to children
- £2,500 to grandchildren
- £1,000 to other family and friends.
By using any weddings you attend as an opportunity to make tax-free gifts, you can make more headway in reducing the size of your estate.
Small gifts of less than £250 are typically tax-free
As well as using these gifting exemptions, you are also free to make small gifts of less than £250. You can make an unlimited number of these gifts to whoever you’d like, provided that they don’t receive another gift from you that’s covered under another exemption.
Again, while £250 is not a significant sum on its own, you could notably reduce the size of your estate by regularly making small gifts to your children and grandchildren.
Understanding the 7-year taper rule
Beyond using these gifting exemptions, you can in theory make a gift of any size and have it fall outside the value of your estate, provided that you outlive the gift by at least seven years. This is known as a “potentially exempt transfer” (PET).
However, if you die within these seven years, the gift will be subject to a rate of tax on a sliding scale known as “taper relief”, depending on how soon you died after making the gift. The rate of tax your beneficiary will be subject to will then be:
- 40% if you die within the first two years of making the gift
- 32% if you die between years three and four
- 24% if you die between years four and five
- 16% if you die between years five and six
- 8% if you die between years six and seven.
If you want to use this method, it can be sensible to start planning sooner rather than later to give yourself the best chance of reaching the seven-year threshold and having the entire sum fall outside your estate.
It’s also important to note that PET gifts like this will be the first part of your estate calculated in your NRB. As a result, if your total PETs don’t exceed your remaining NRB, your beneficiaries won’t benefit from taper relief at all.
Making regular gifts from surplus income
Finally, one other option you have is to make regular gifts from your surplus income. This involves making a consistently repeated gift to your beneficiaries, perhaps for something such as school or university fees.
If you do want to explore this option, you must make sure that you meet the following criteria:
- The gift must be made regularly. You must be able to prove that you are making the gift on a regular basis, not as a one-off.
- The gift must come directly from your income. This could be employment or pension income, but the money must come from here rather than from you dipping into your savings and passing this money to your beneficiaries.
- You must be able to maintain your current lifestyle. You cannot change your lifestyle, such as moving to a cheaper home, in order to pass this money on for IHT purposes.
It may be sensible to speak to an expert if you’re interested in exploring this option to ensure that you remain within HMRC’s rules.
Concerned you’ll be leaving your family with a tax bill? Speak to us
If you think you may be in the position of leaving your family with an IHT bill on your death, then we can help at Cordiner Wealth.
We’ll show you the most suitable options for helping to reduce your IHT liability so that your family are the biggest beneficiaries of your wealth.
Email email@example.com or call 0113 262 1242 to find out more today.
The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.
For taper relief/PETs
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.