How inheritance tax gifting rules work

Giving money away while you are still alive can be a great way to cut your inheritance tax bill – potentially to zero. 

Making lifetime gifts not only boosts the value of your legacy; it also means your loved ones benefit from your wealth. 

But while lifetime gifting might sound straightforward, it’s important to be aware of all the relevant allowances and restrictions, to ensure you don’t fall foul of the rules. 

How much can I pass on tax-free? 

Before you start planning your lifetime gifts, it’s important to understand how much you can leave tax-free and work out how much your estate is likely to be worth. 

Everyone can pass on up to £325,000 tax-free, which is referred to as your nil rate band (NRB). But you may be able to pass on more than this before IHT becomes payable.  

For example, if you’re passing a family home to direct descendants, and the total value of your estate is below £2 million, you can also pass on a further £175,000 tax-free via the residence nil rate band (RNRB).

For estates that are worth more than £2 million, the RNRB is tapered away at a rate of £1 for every £2 over the threshold. 

Transfers between spouses on death are also tax-free, and when the first person dies, the survivor can inherit any of their NRB that hasn’t been used. 

This means that, if you’re married or in a civil partnership and own a family home, you could pass on as much as £1 million between you, without paying any IHT. 

If you’re single (either never married or divorced) and passing on a family home, you can pass on £500,000 tax-free. 

You’ll also need to tot up the value of your estate, which is the total value of your property, possessions, savings and investments, less any debts.

How lifetime gifting cuts your IHT bill 

 Any money in your estate over your tax-free allowance will normally be taxed at 40% when you die. 

So, by giving money away while you’re still alive, you’re taking money out of your estate and reducing the amount that will be subject to tax. 

In practice, this could be the difference between a loved one getting £10,000 now or £6,000 after you have died (once 40% tax has been deducted). 

Inheritance tax gifting rules 

The catch is that when you give money away, it might not automatically be tax-free.  

In order for no IHT to be payable on the gift, you will normally need to live a further seven years. You might hear this referred to as ‘the seven-year rule.’ 

Taper relief, which gradually reduces the rate of IHT payable, might apply if you die between three and seven years after making the gift, but only if the total value of your gifts exceeds the nil rate band. 

However, there are several allowances you can take advantage of to help you get smaller sums out of your estate, without needing to survive seven years. 

These include: 

The annual exemption

Each year you can give away £3,000 tax-free; this can be to one person or split between several people.

If you didn’t use your allowance last year, you can also roll it forward to this year and give away a total of £6,000. 

The small gift allowance

You can give as many small gifts worth up to £250 as you like (as long as you haven’t already used another allowance on any of the recipients already). 

Wedding gifts

You can give up to £5,000 to a child tax-free when they get married (or enter a civil partnership), £2,500 to a grandchild or great-grandchild and £1,000 to anyone else.

This can also be combined with the annual exemption. 

Regular gifts from surplus income 

It’s also important to be aware that you can give away as much as you like tax-free, by making regular gifts from your surplus income. 

So long as you can demonstrate that payments were made from your income, were regular and that your standard of living didn’t suffer as a result, no IHT will be payable on the gifts.

This could be helpful, for example, if you want to help pay for your grandchild’s education, contribute to a junior ISA or even top up your own child’s pensions. 

This allowance is not frequently used, and you will need to keep meticulous records to prove that your gifts meet the criteria (including details of your income and expenditure).

However, over the years, it can be a helpful way of getting money out of your estate. 

Can I give away my house to avoid IHT? 

Rising house prices mean that an increasing number of people are paying IHT and, with large amounts of wealth tied up in the family home, they may not necessarily be able to make cash gifts to their loved ones. 

For this reason, it’s not unusual for older homeowners to consider gifting their family home to their children to get the property out of their estate before they die. 

However, this isn’t easy to do. 

While you can give away your home to avoid paying IHT, you would need to give it away wholly: if you carried on living there, it would be regarded as a ‘gift with reservation of benefit’ and would still be subject to IHT. 

To get around this rule, you would need to pay full market rent to your children. 

What to think about first 

Gifting can be a straightforward way to get money out of your estate and reduce the amount of inheritance tax your loved ones pay.

Many people also enjoy seeing their family benefit from their wealth while they are still alive. 

But it’s important to plan and ensure you can afford to give money away. For example, if you need long-term care in later life, it’s likely that you will need to foot the bill. 

You’ll also need to think about how much control you would want over who gets your money and when. 

Get expert inheritance tax advice 

These are just some of the reasons why it makes sense to talk to a qualified financial adviser who specialises in estate planning and the best ways to cut an inheritance tax bill. 

They will be able to work out how much IHT you will likely need to pay and offer advice on your options. 

If lifetime gifting is the right approach for you, they will also help you work out how much you can afford to give away, how to time and structure your gifts, and ensure that all the necessary records are kept.   

And if you do want more control over your gifts, they will also be able to discuss trusts with you too. 

Let Unbiased match you with a specialist financial adviser near you.