“Giving while living” and inheritance tax
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Dealing with inheritance tax (IHT) is often assumed to be dealt with at a person’s death. Yet you are not limited to planning your estate for this one-off event. You can also mitigate IHT by making gifts across your lifetime. In this guide, our Grantham financial advisers explain how gifts can be used to lower an IHT liability in 2023-24. We hope this content is helpful. If you want to discuss your financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
How inheritance tax works
In 2023-24 inheritance tax (IHT) is levied at 40% on the value of an estate once its owner dies and the estate’s value goes over £325,000. Below this “allowance”, no IHT is due. For instance, if you rent in retirement (not owning a home) and you hold £300,000 in a general investment account when you die, then all of this should pass to your beneficiaries without IHT.
Each person is entitled to their own IHT-free allowances. Spouses and civil partners can also transfer any unused allowance to the other person if one person dies. In effect, this allows such a couple to “combine” their IHT-free allowances to a total of £650,000 in 2023-24. Another rule, called the Residence Nil Rate Band, lets an individual pass down an extra £175,000 to their “direct descendants” (e.g. children) if their estate includes the family home. For a married couple or civil partnership, therefore, it is possible to pass down a £1m total estate without an IHT liability, depending on your circumstances and using careful financial planning.
How gifts relate to inheritance tax
The above rules about IHT largely come into effect when an estate owner dies. However, you can also make gifts during your lifetime to help lower a future IHT bill. In 2023-24, you can give away up to £3,000 per tax year (to one person or multiple people) without the gift(s) counting towards the value of your estate. For instance, suppose your taxable estate is worth £500,000 when you die, leaving £175,000 subject to IHT at 40%. Yet suppose, in an earlier tax year, you also made a £3,000 gift. This would reduce your taxable estate to £172,000.
Making full use of this Annual Exemption over a prolonged time period could significantly reduce a future IHT bill. For example, suppose you made £3,000 in gifts annually over a 10-year period. This could reduce your taxable estate by £30,000. In addition to this, you can give up to £5,000 to a child for a wedding (or £2,500 to a grandchild or great-grandchild or £1,000 to anyone else). Your partner is also entitled to these tax-free allowances for gifts. Beyond these limits, your gifts may be subject to the “7-Year Rule” which stipulates that a gift is not counted as part of your estate for IHT purposes if you survive it by 7 years. However, relying on this rule can be risky. If you die within 7 years, then the gift may be subject to IHT at a “tapered rate” (e.g. 16% if 5-6 years have passed between gift and death).
Ideas for estate planning
One benefit of making gifts during your lifetime is that you get to see the joy and impact it makes on your loved ones. Perhaps your gift helps a child get onto the housing ladder or supports your grandchild through university. Yet this could also help to save on a future IHT bill. Bear in mind the conditions that the UK government imposes. For instance, if you give your car to your child and continue to drive it, then it is a “gift with reservation” and IHT may still apply.
The earlier you start using your Annual Exemption, the better. This gives you more time to reduce your taxable estate each financial year. Also, if you make gifts which exceed the £3,000 limit, then you are more likely to survive the 7-Year Rule if you are younger. Keep careful track of any gifts you make. The date, value and recipient of the gift should be recorded, with evidence ready to produce later (e.g. bank statements). Note that, in addition to your £3,000 Annual Exemption, you can also make as many individual £250 gifts as you like without an IHT liability.
Be careful with using trusts to make gifts. There is still a misconception that putting assets into a trust makes them exempt from IHT. This is not necessarily true. Trusts can be valuable tools for passing wealth down to loved ones, yet there are many different types – each with its unique rules and tax treatment. For instance, assets held in a bare trust may be free from IHT, but only if you (the giver) survive the transfer by 7 years. Consider seeking professional financial advice to explore how trusts could play a role in your estate plan.
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
