When planning your estate, making gifts during your lifetime is a strategy often used to reduce inheritance tax (IHT). This guide Will help you understand how gifting works under UK inheritance tax law, including potential exemptions and allowances that allow for tax-free gifts.
The law on gifting and inheritance tax
Gifts made during your lifetime are considered Potential Exempt Transfers (PETs). These gifts can include cash, property, or other valuable items. However, if you pass away within seven years of making the gift, it could be subject to inheritance tax. Understanding the exemptions and reliefs available can help you minimise this tax liability.
Tax-free allowances (Nil Rate Bands)
Before diving into exemptions, it's important to understand the Nil Rate Band. This is the amount of your estate that is free from inheritance tax, currently set at £325,000 (fixed until April 2028). If you are married, this allowance can be transferred to your spouse upon your passing if unused, doubling the amount of tax-free inheritance.
If you leave a property to a direct descendant (e.g. child or grandchild), you may also qualify for the Residence Nil Rate Band, an additional allowance of up to £175,000 (also fixed until 2028). Together, these allowances can help reduce the inheritance tax your estate might otherwise owe.
Gifting and the seven-year rule
If you make a gift and survive for seven years, it Will not be included in your estate for IHT purposes. However, if you pass away within seven years of making the gift, the gift’s value could be added back into your estate, potentially resulting in an IHT charge.
That said, the IHT liability reduces with taper relief if the gift was made between three and seven years before death.
Taper relief breakdown
Years between gift and death Rate of tax on the gift
- 3 to 4 years - 32%
- 4 to 5 years - 24%
- 5 to 6 years - 16%
- 6 to 7 years - 8%
- 7 or more - 0%
Exemptions for gifts
Several exemptions allow you to make tax-free gifts during your lifetime. These include:
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Annual exemption - Each individual can gift up to £3,000 per year free from inheritance tax. If you haven’t used this exemption in the previous tax year, you can roll it over to give a total of £6,000 tax-free.
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Wedding gift exemption - Gifts made in relation to weddings or civil partnerships can also be tax-free. You can gift:
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£5,000 if you're a parent of the couple,
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£2,500 if you're a grandparent, or
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£1,000 for anyone else.
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Small gift exemption - You can make gifts of up to £250 per person per tax year, as long as the recipient has not benefited from other gift allowances.
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Normal expenditure exemption - Regular gifts that form part of your normal expenditure can also be exempt, provided they don’t impact your standard of living. This can include birthdays, holidays, or even regular financial support to loved ones.
What happens if your estate exceeds the Nil Rate Band?
If your estate’s value exceeds the Nil Rate Band, any gifts made in the last seven years before your death Will be included in the estate’s value. If your estate still exceeds the tax-free limits after factoring in gifts, inheritance tax will apply to the remaining amount at a rate of 40%.
Plan smartly to maximise gifting benefits
Gifting is a great way to manage your estate and potentially reduce the inheritance tax owed by your beneficiaries. However, it’s important to plan carefully. Understanding the rules and exemptions can help you make the most of your allowances, while ensuring that you do not inadvertently trigger a tax charge.
For more detailed advice on how to best structure your gifting, please don’t hesitate to contact Wills Services for professional guidance.
