Gifts & IHT: a short guide
IHT has come back into the spotlight after the Autumn Statement. In November 2024, the Chancellor (Rachel Reeves) announced some key changes to pensions, Business Relief and other areas that will know important knock-on effects to estate planning.
This has raised the question: do individuals need to adapt to mitigate inheritance tax (IHT) in light of the changes? Below, our Grantham financial planners highlight a key area of estate planning that could help: gifts.
Gifts & IHT
In the UK, inheritance tax (IHT) is typically due upon death when someone’s “estate” (their total assets minus liabilities) is valued at over £325,000. At which point, a standard rate of 40% usually applies. For instance, a £500,000 estate might face a £70,000 IHT bill (assuming no allowances like the residence nil rate band).
A gift, however, can place an asset outside of an individual’s estate. This can potentially exclude it from the calculations when those involved in the “probate” process value everything. The end result could be a reduction in IHT.
To take a simple example, suppose someone gave away £20,000 ten years ago. They die and leave a £480,000 estate. Assuming no other allowances, the estate might face a £62,000 IHT bill. However, suppose this person did not donate £20,000 and died with a £500,000 estate. In this case, the IHT bill could be £8,000 higher.
The Annual Exemption
Can someone simply give away as much as they like, avoiding IHT on the value of those gifts? The answer is no. Certain rules govern the relationship between gifts and IHT.
In particular, the Annual Exemption rules state that an individual can give away up to £3,000 in gifts each tax year without these being added to the estate’s value upon death.
The rule allows someone to give £3,000 to one person or split the £3,000 between several people. If the full £3,000 is not used in a tax year, any unused amount can be “carried forward” by one tax year. After that, the unused Annual Exemption is lost.
There are some special additions to this rule that are worth noting. For instance, an individual can also give away as many gifts as they like (up to £250 per person, provided you have not used another allowance on that person).
Gifts for weddings and civil ceremonies also get their own annual exemption – i.e. £5,000 to a child, £2,500 to a grandchild, and £1,000 to anyone else.
The 7-Year Rule
It is possible to make gifts in excess of £3,000 and exclude them from the value of your estate for IHT purposes. However, to achieve this, you must survive the date of the gift by 7 years.
This “7-Year Rule” is quite widely known but often misunderstood. For instance, some people assume that they can transfer ownership of their house to a child, continue to live there, and make the property exempt from IHT if they live another 7 years. The rules are more complex than this, however.
See our dedicated article on Transferring Your Home To Your Child’s Name for more information on this specific point. Take particular note of the condition known as “gift with reservation”, which can lead to a gift still being counted as part of your estate if you continue to benefit from it.
There is always the risk that you may die within the 7-year period following the date of the gift. In which case, a tapered IHT rate may apply, depending on the duration. For instance, if 3-4 years have passed between gift and death, a 32% IHT rate applies. However, in the case of a 6-7 year duration, the rate is 8%.
The 7-year rule can be a useful component of many clients’ estate plans. Yet, it is vital to plan for the potential risks (e.g. dying within the next 7 years). Here, a financial adviser can help you engage in effective contingency planning and build in redundancies.
Final thoughts
The Autumn Statement confirmed an important change to the UK’s inheritance tax system. In April 2027, pension pots will no longer be exempt from the value of an estate. As such, some pensions could fall into the IHT “net”.
Another key change in November 2024 was the planned introduction of a new system for Agricultural Property Relief (APR) and Business Relief. This will have important implications for many farmers and business owners.
For more information about how the former could be affected, see our dedicated article here: How Will Farmers Deal With IHT Now?
In many cases, gifts could play a vital role in mitigating a needless IHT liability. One idea is to consider gifts from regular payments. Here, it is possible to give frequent tax-free gifts to another person, provided you meet certain conditions (e.g., you meet the definition of “normal expenditure out of income”).
If you’d like to make sure you’re taking the right steps to safeguard your financial future, please get in touch.
