If you are making long-term plans to pass on money and assets to your loved ones, you might be considering making gifts during your lifetime. There may be many reasons why you would want to make significant gifts to friends and family, but a common question which arises is: will this avoid inheritance tax? Or is it better to just pass it on through my will?
In this blog, we’ll look at how the rules work around inheritance tax and lifetime gifts, and highlight the ways in which some of them may be exempt.
How inheritance tax generally works
When someone dies, their estate is assessed for inheritance tax. If there is any payable, it is ordinarily the responsibility of the deceased person’s executors to pay any tax owed from the estate’s assets, before dividing what’s left according to the terms of the will. A similar administration process takes place if the deceased person did not make a will.
Each person has a tax-free allowance of £325,000 for inheritance tax purposes. This means that the first £325,000 of someone’s taxable money and assets are taxed at 0% and anything above this is taxed at 40%.
This is only a basic overview of how the inheritance tax regime works. A person may also be able to claim separate tax-free allowances if they are widowed, or if they own and live in a property which is passing to their children or other descendants. There are also various exemptions which can apply. For example, anything left to a spouse or civil partner is exempt from inheritance tax.
So, for example, if a single person with no children’s taxable estate is valued at £500,000, the first £325,000 incurs no tax, and the remaining £175,000 would be taxed at 40%.
Will lifetime gifts I make be taxable?
Lifetime gifts can be taxable for inheritance tax purposes, but it will depend on the circumstances.
The general rule is that if someone makes a gift during their lifetime, and dies within 7 years of making it, the value of that gift can be taken into account as part of the inheritance tax calculation on their estate.
If they live longer than 7 years from the date of the gift, then it will be considered exempt and will not be taxable. For this reason, these are sometimes referred to legally as ‘potentially exempt transfers’, as they may be exempted if at least 7 years pass between the date of the gift and the date of death.
Gifts made within 7 years of death
Where someone has died within 7 years of making a gift, it has the effect of ‘using up’ a corresponding portion of their tax-free allowance (the £325,000 mentioned above), and so reduces the amount available to their estate.
For example, Ann makes a £25,000 gift to her friend in 2020, and in 2023 Ann passes away. Her estate is valued at £310,000. As she did not survive the gift by more than 7 years, the £25,000 is counted towards her £325,000 tax-free allowance. This leaves £300,000 of the allowance available to cover her estate. As the estate is worth £310,000, £10,000 falls above the remaining tax-free allowance and would be subject to inheritance tax at 40%.
Lifetime gifts exceeding the tax-free allowance
If the total value of lifetime gifts within the 7 years before death exceed the £325,000 tax-free allowance, inheritance tax will be payable on the value of the gifts above the threshold. This will also have the effect of using up all of the tax-free allowance. However, if this occurs, a provision called ‘taper relief’ can reduce the amount of tax that is payable on such gifts.
Taper relief operates on a sliding scale, reducing the tax rate payable based upon the amount of time that has elapsed from the date of the gift. These rates are as follows:
- If the gift happened within 3 years of the date of death, then the gift will still be taxed at 40% – in other words, taper relief does not apply.
- If over 3 years have elapsed but less than 4 then it will be taxed at 32%
- If over 4 years but less than 5, the rate will be 24%
- If over 5 years but less than 6, the rate will be 16%
- If over 6 years but less than 7, the rate will be 8%
(And gifts made over 7 years earlier are completely exempt)
It is important to remember that taper relief will only apply if lifetime gifts exceed the tax-free allowance.
Who pays the tax on lifetime gifts?
If the lifetime gifts made within 7 years of death do not exceed the £325,000 allowance, then the usual payment of inheritance tax applies. Namely, that the deceased person’s estate will pay any inheritance tax that is owed.
However, where the tax-free allowance is exceeded by lifetime gifts, it will instead be down to the people who receive the gifts to pay any inheritance tax that is owed on them.
For example, Stephen makes several gifts during his lifetime: £50,000 to Priti in 2001, £100,000 to Anthony in 2004, £250,000 to Bella in 2005, and £20,000 to Calvin in 2009. Stephen dies in 2010. Here’s how inheritance tax would be affected (assuming no other reliefs and exemptions apply):
- The gift to Priti was made over 7 years before Stephen’s death so it would be exempt from inheritance tax.
- The gift to Anthony would use up £100,000 of Stephen’s tax free allowance, so no tax would be payable.
- The gift to Bella would use up the rest of the allowance, with £25,000 of the gift’s value remaining. It was made just over 5 years before Stephen’s death, so taper relief would apply to reduce the tax rate on it to 16%. Bella would have to pay the 16% inheritance tax on the £25,000.
- The gift to Calvin would be completely taxable as none of Stephen’s tax free allowance remains. As it was made within a year of Stephen’s death there would be no taper relief applicable, and so Calvin would have to pay 40% tax on the full £20,000.
Lifetime gifts that are exempt from tax
Lifetime gifts to certain recipients are exempt from inheritance tax.
There will be no inheritance tax to pay if you make a gift to:
- Your spouse or civil partner (as long as they are a permanent UK resident)
- A charity
- A political party
Annual exemption
There is also an annual exemption allowance for gifts of up to £3,000 per tax year. This can apply to one gift of £3,000 or smaller gifts to several people totalling that sum. Any unused exemption can be carried over to the next tax year – but only for one year – so the maximum exemption you could have in this way would be up to £6,000.
Other gift exemptions
Small gifts of up to £250 are also exempt from inheritance tax. These are applied per person per tax year, meaning you can make many gifts of up to £250, to as many people as you like, but a gift will no longer be exempt if the recipient receives more than £250 from you in that tax year.
Exemptions are also made for gifts for weddings or civil partnerships. These are allowed at up to:
- £5,000 for one of your children
- £2,000 for one of your grandchildren or great-grandchildren
- £1,000 for any other person
Wedding gifts can be combined with other gift exemptions.
Additionally, gifts from your regular income may also be exempt from inheritance tax. These gifts must be made on a regular basis from your income, and you must be able to afford the gift taking into account your income and living costs.
Getting legal advice on lifetime gifts
If you would like advice on lifetime gifts, and other ways to take care of loved ones after you are gone, Ison Harrison’s wills and probate solicitors are on hand to help.
Get in touch with us if you would like to chat about your circumstances.
