Giving money or assets to your beneficiaries while you’re still alive is one of the most common strategies to pre-emptively reduce inheritance tax. However, there are a number of rules around what you can give, and when you can give it.
Indeed, when the value of your estate is calculated, it will include the total value of certain gifts you made in the seven years before your death - or at any time if you continued to benefit from the gifted property thereafter (these are known as ‘gifts with reservation of benefit’).
Lifetime gifts generally fall into one of the following three categories:
- Exempt transfers
- Potentially exempt transfers (PETs)
- Chargeable lifetime transfers
Exempt transfers
Exempt transfers are gifts you can legitimately make at any time, without incurring any inheritance tax. These include:
- Gifts of any value between spouses or registered civil partners
- Annual gifts of up to £3,000 in each tax year
- Regular payments out of your income. Regular payments paid directly out of your income can help stop the value of your estate increasing. There’s no set limit on these payments, but they will only qualify for exemption if you have enough income left to fund your normal lifestyle.
- Wedding gifts or civil partnership ceremony gifts (you can give £5,000 to your children, £2,500 to grandchildren or £1,000 to anyone else).
- Small gifts of up to £250 per person, per year
- Gifts to charities, political parties or national organisations (donations are tax-free during your lifetime, and when you leave money to charity in your will).
Potentially exempt transfers (PETs)
Potentially exempt transfers (PETs) are gifts to individuals (as well as gifts into certain specific types of trusts) which exceed the available exemptions above.
There is no inheritance tax to pay straight away when you make the transfer, but IHT will need to be paid if you die within seven years and the value of the PET puts you over the nil rate band. Read our guide to IHT for more about the nil rate band.
Gifts made less than three years before your death incur the full 40% inheritance tax charge. Gifts made three to seven years before you die are taxed on a sliding scale known as taper relief.
For example, if you make a PET of £100,000 but die within three years with an estate value of £300,000, the PET is added to the value of your estate to make £400,000. There’ll therefore be an IHT bill of £30,000 (40% of the £75,000 over the nil rate band).
Assuming you live for more than seven years following the PET, its value wouldn’t be added to your estate when you die. In this case, there would be no inheritance tax to pay on the gift.
Chargeable lifetime transfers
A transfer is classed as a chargeable lifetime transfers (CLT) when an individual makes a gift that is not outright, for example, a gift into a flexible or discretionary trust.
There will be no inheritance tax to pay when making a CLT, as long as your total amount of CLTs in the previous seven years is less than the available nil rate band.
If the CLT, when added to the total amount of CLTs in the previous seven years exceeds the nil rate band, there will be a lifetime inheritance tax charge of 20% on the excess amount.
Chargeable lifetime transfers will usually fall outside of your estate for IHT purposes if you survive for at least seven years after the CLT was made. However, if you die within seven years of making the CLT, then its value will be part of your estate.
Any inheritance tax you already paid on a CLT when you were alive will be deducted from any IHT due on it after your death.
Things to consider before making lifetime gifts
Lifetime gifts are often seen as a simple way to reduce inheritance tax, but as you can see above, it’s a complicated matter that needs serious thought.
As well as ensuring you abide by the rules, you’ll need to consider the affordability of giving gifts, without leaving yourself short in your later years – when you may need to pay for things like care.
You’ll also need to think about when you want your beneficiaries to gain access to the assets you gift them. For instance, you may want to give money to your children or grandchildren but retain control over what age they receive it. This can usually be done by placing the money into trust.
If you’re looking at ways to manage your estate value, it might be a good idea to speak to your Specialist Financial Adviser from Wesleyan Financial Services.
Please bear in mind that advice in relation to inheritance tax planning is not regulated by the Financial Conduct Authority.