How to make gifts to reduce Inheritance Tax

When putting a financial plan in place, it’s heartening to know that you might provide security for your children or grandchildren in the future. There’s currently no Inheritance Tax on pension savings, making them a smart way to pass on assets. But this is set to change in April 2027. In this article, we consider strategic gifting as an alternative.

Chancellor of the Exchequer Rachel Reeves announced changes to the rules around pension savings and Inheritance Tax (IHT) in the Autumn Budget 2024. Assuming they go ahead, this will have a significant impact on estate planning. Many clients are wondering what can be done.

‘Gifts to family or friends can be a good way to reduce the value of your estate for Inheritance Tax purposes,’ says Chartered Wealth Manager Paul Willans. ‘However, it’s important to remember that we don’t yet know the details of the proposed legislation. As with any aspect of financial planning, the first rule is not to rush into anything.’

Will your estate be subject to Inheritance Tax?

There’s no IHT on the first £325,000 of your estate. This rises to £500,000 if you pass on your family home to your children or grandchildren. If you’re married or in a civil partnership, you can combine these allowances and pass on up to £1 million tax-free altogether. You can also transfer assets between each other free of IHT. The rest of your estate is taxed at 40%.

Does it make sense to gift money now to avoid IHT?

While you may wish to look after your family, the starting point is to consider your situation and how it might evolve. For example, will your income rise with inflation? And how might your expenses change, if say you needed to fund care costs?

‘At AJB Wealth, we find that cashflow analysis gives clients greater clarity over how their financial situation may develop in the future. It helps inform their decisions,’ says Willans, Managing Director of the Hampshire firm. ‘It is particularly useful for exploring and illustrating different scenarios.’

Is there a gift tax in the UK?

Unless the gift is to a discretionary trust, and in excess of £325,000, gifts are not usually taxed at the time they are made. However, if the giver dies within seven years, they will be considered part of their estate and subject to Inheritance Tax. However, there are exemptions.

If you decide to make gifts, you can consider various ways to do so:

1. Annual exemptions add up over time

You can gift up to a total of £3,000 per year without it being added to your estate for IHT purposes. This can comprise of assets or cash. You can also carry forward any unused exemption for one year. While the amounts are relatively small, they add up over time. Especially for a couple, who can jointly gift £6,000 per year. This means that over a 10-year period, an individual can give £30,000, and a couple £60,000. If this is invested, the recipient will also benefit from investment growth, making the impact greater still.

In addition, you can give small gifts of £250 per year to any number of people – providing they haven’t received a gift from you under another exemption.

2. Tax-free wedding gifts

Wedding or civil ceremony gifts are exempt up to £1,000 per person, or up to £5,000 for a child and £2,500 for a grandchild or great-grandchild.

3. Regular gifts out of surplus income

Often overlooked, it is also possible to make regular gifts out of surplus income which are immediately exempt from tax. To qualify, these gifts must be:

• Part of your normal expenditure
• There should be an intention to make regular gifts of this nature
• Made out of income, not capital
• Leave enough for you to enjoy your normal standard of living

It’s particularly important to keep clear records to illustrate that your gifts fulfil the criteria.

4. Potentially Exempt Transfers (PETs)

If you make gifts that don’t qualify for one of the above exemptions, they are usually classified as Potentially Exempt Transfers. This means that the gift, whatever size, will be exempt from Inheritance Tax if you survive for seven years afterwards. If the person making the gift dies within three years, Inheritance Tax is payable at the full 40 per cent. From three to seven years, the percentage gradually reduces.

5. Gifts to charities and political parties

Gifts to UK charities and political parties are usually exempt from Inheritance Tax.

A note on gifts to children

If you wish to make gifts to children or grandchildren under 18, Junior ISAs or Junior SIPPs are tax efficient options. While they would be subject to the usual gifting rules, they would still benefit from tax advantages. For example, a parent or grandparent can contribute £2,880 per year into a Junior SIPP, with the government adding a further £880.

Junior ISAs can be accessed when the child turns 18 and a Junior Sipp at retirement. (The minimum age rises to 57 in 2028, and is likely to rise further in the future.)

For larger sums, a trust would be the way forward, but the various options would need careful consideration, with professional advice.

In conclusion: plan carefully and keep meticulous records

A clear strategy is essential. Timing is important, and you might need to consider the order in which you make gifts and how they might affect each other. Good records will help establish that you have acted within the rules.

‘Making gifts can greatly reduce the amount of Inheritance Tax charged on your estate, but it takes meticulous planning,’ says Willans. ‘It also pays to consider the options at an early stage, as this is when your actions can have the greatest impact.’

AJB Wealth is well placed to help with all aspects of financial planning and investment. To discuss your situation, please book an exploratory meeting, or call us on 01428 774 070.

Important: The content of this bulletin is for general consideration only and does not constitute advice. No action must be taken, or refrained from being taken, without advice. This company accepts no responsibility for any loss occasioned as a result of any such action, or inaction. References to tax rates and allowances are based on current tax law and are subject to change.