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Written by Emily Cross.
21 minute read
After someone passes away, dividing their estate between loved ones can sometimes bring unexpected complications. Similarly, difficult conversations occur when a loved one is still alive and they are considering what to do with their estate when they die. This is then complicated by the complex nature of the UK tax system and its seemingly endless list of rules and regulations.
While some tax planning professionals will recommend making gifts to relatives as a way to minimise tax exposure, understanding what this means in practice may prove difficult. Here at Aura, we believe that simple, straightforward explanations can be an effective way to help you understand your options.
Our guide on inheritance tax on gifts is designed to introduce you to your options in a way that you can work through at your own pace. It’s the same open and transparent approach we take when we help families understand how things like a prepaid funeral plan or direct cremation service work.
Key takeaways:
Inheritance tax (IHT) is the money you will have to pay HMRC on certain assets, items, and amounts of money that you pass to a loved one or relative upon death. While it may seem unfair that you have to pay any form of tax on things you have already bought with money that you have paid tax on, inheritance tax is a longstanding part of the UK tax system and one we are all obligated to comply with.
The focus of our guide is on gifts — valuable items and amounts of money that are given to a relative or friend with nothing expected in return. A purchase is when an asset changes hands in exchange for money, a gift is when nothing is received in return. There are a series of complex rules that govern whether or not, and how much, inheritance should be levied on gifts in the UK.
The first thing you may want to consider is whether to make a gift during your lifetime or wait for it to be transferred after you die. One thing to consider is that if you give a gift while you are still alive and you live for more than 7 years after the date you give it, you are unlikely to have to pay any inheritance tax. Speaking to a tax planning professional will help you understand your inheritance tax liability in your specific case.
It may also be useful to know that you have an annual exemption of £3,000 that allows you to gift a loved one this amount each year tax-free. Alternatively, you also have the option of splitting the total amount between two or more individuals.
Taking a closer look at the 7-year rule for inheritance tax may help you to understand your options and allow you to find conversations with tax professionals more accessible.
Because inheritance tax is a tax on the assets that pass from you to a loved one at the time you die, there has to be a limit on how far back you can go when it comes to taxing gifts made when you were still alive. HMRC understands that gifts allow people to reduce the size of their estate and, therefore, their inheritance tax liability. However, they also acknowledge that looking too far back (say, 15 or 20 years) might feel unreasonable, especially if the gift had nothing to do with avoiding tax.
The limit is set at 7 years so that if you survive longer than this period of time after giving a gift, the recipient of the gift will not have to pay any inheritance tax when you die. There is also a sliding scale that reduces the amount the recipient has to pay based on how long they live after making the gift.
If you give gifts that total more than £325,000 while you are still alive, taper relief will determine how much the recipient of the gifts has to pay in inheritance tax when you die:
Taper relief is put into practice to ensure that there is not a sudden, unexpected jump in tax exposure when a loved one lives just a few days less than 7 years. The idea is to have a sliding scale in place that reflects the amount of time they continued to live after giving the gift.
There is an annual exemption that you can make use of every year when you want to strategically reduce the size of your estate in a way that minimises your tax exposure.
HMRC states that your £3,000 annual exemption can be made to a single individual, or it can be split between two or more parties as you see fit. You will qualify for the annual exemption regardless of your age, who you are gifting it to, or how much your total estate is worth.
HMRC also offers an option to carry forward any unused annual exemption from the previous tax year and use it in the current tax year. If, for example, you didn’t use any of your exemption the previous year, you would be entitled to give a gift of up to £6,000 tax-free in the current tax year. It is important to note that while the exemption can be carried forward, it can only be carried forward by one tax year, and any unused exemptions from earlier tax years cannot be used.
You may also be interested to know that there is a small gift exemption of £250 per person and that you can give as many of these gifts as you like, provided the person you are giving to has not already had another allowance used on them. This is so that you can give birthday and Christmas gifts to friends and loved ones without them having to pay inheritance tax on the amounts you give.
As outlined by HMRC, there is also a provision in the UK tax system to give tax-free gifts for weddings and civil partnerships for the following amounts:
The idea here is that you can help a relative or person you care about pay for their wedding without them having to pay inheritance tax if you die within 7 years of the service.
There is also a 100% inheritance tax exemption on gifts made to your spouse or civil partner, allowing you to gift them however much you want from your estate within any given tax year.
Things can quickly get complicated in the world of inheritance tax, with PETs sometimes causing confusion.
A Potentially Exempt Transfer (PET) is a lifetime transfer of something of value (money, property, shares, etc.) that satisfies a couple of key conditions:
While this is something that a tax planner will talk you through, you may be pleased to know that all PETs become 100% exempt from inheritance tax if you live for more than 7 years after making the gift.
A PET becomes a chargeable transfer (something on which inheritance tax will be levied) if the person who made the gift dies within 7 years of making it. In cases like these, taper relief rates will reduce the amount of inheritance tax that is to be paid if the giver of the gift died within 3-7 years of giving it.
Using a tax professional to help with how to set up a trust can reduce your tax exposure by effectively reducing the size of your estate at the time you do. A key part of calculating the total exposure to inheritance tax is to decide what is a CLT and what is not, and this is something the tax professional can help you with. CLTs will immediately become due for inheritance tax because of the nature of the value they hold. Although this may sound overly complicated right now, the main point is to be aware of the fact that a trust reduces your tax exposure rather than setting it to zero.
Starting to redistribute your estate before you die is where gifting comes in, and it is something your tax professional may well advise.
You can gift your children and grandchildren money from your estate, but if you die within 7 years of doing so, a sliding scale of inheritance tax rates will be applied. Some families may choose to use their £3,000 annual exemption or to structure gifts so that they come from surplus income.
HMRC classifies things such as monthly deposits into a savings account as surplus income, and allows you to gift it tax-free to your children or grandchildren.
You may also find that it is helpful to consider gifting property and other tangible assets. While you can gift your spouse or civil partner everything without having to pay inheritance tax or capital gains tax, the same is not true if you are gifting property to anyone else.
Although an exhaustive list of scenarios is beyond the scope of this guide, here are some common situations that may help shine a light on how the system works:
Hopefully, these examples provide an insight into how complex the system can be, but also that you can quickly home in on the ideal approach with the help of a tax professional.
The importance of writing a will lies in the fact that it allows your family to know what your wishes are when you die. Our guide on what probate involves can help you feel comfortable with the basics so that you don’t have to look in multiple places for the information you want.
It is natural to want to protect your assets so that you can help your loved ones at what may be a difficult time, both emotionally and financially, for them in the near future. The important point to note here is that although there may be grey areas in the tax system, we are all legally obligated to structure our estates and financial arrangements in a way that is fully compliant with the law.
A common way to do this is to start gifting using your surplus income. The money you gift must have already had income tax paid on it and cannot be part of the capital value of your estate. In other words, it has to be money you are making and paying tax on, and cannot be money that you come by from selling things such as your car, home, or family heirlooms. You also cannot reduce the quality of your life by doing so, which rules out cashing in any investments or withdrawing any existing savings you may have.
Figuring out who is liable for inheritance tax on gifts when the giver of the gift dies within 7 years can be a complex process, especially if they die without a will. While the inheritance tax will generally be paid from the estate, this can become a difficult conversation to have if the way in which the estate is to be divided and redistributed is being contested or disputed. This can lead to instances where the person who received the gift and spent the money already has to then pay the inheritance tax during what might be a period of intense grief.
You may decide that you wish to give a gift to a friend or loved one to protect your estate from inheritance tax. Not only will this help with any settling of affairs that you may wish to have in order during your lifetime, but it can also play a role in reducing the stress and upset that your surviving loved ones may experience when you die.
The most common way to find someone who can help you with your inheritance tax liability on gifts is to speak with an independent financial advisor in your local area. Doing so can provide the following benefits:
An independent financial advisor can help reduce the stress on you and your loved ones at a challenging time. There are also other steps you may consider taking.
Planning for and then dealing with the loss of a loved one can be one of the most challenging and emotionally testing things you can do, and we completely understand the journey you may be on right now.
When you are trying to process the loss of a loved one, dealing with the tax system may naturally feel overwhelming. In our experience, many families find that breaking things down step by step and referring to our inheritance tax guide when they feel ready can help.
If you are someone who finds that talking things through and staying busy can help you process grief, you may want to look into other areas where money from the estate may be needed. Looking at typical funeral plan costs is a way of starting to calculate the overall outgoings from your relative’s estate.
Some find that even a small initial search can help them start to process their loss and can go a long way towards ensuring they can plan a service they feel is right. However, other members of the family may want to move at a different speed, in which case you may find it helpful to refer to our advice on solving funeral arrangement disagreements.
While a tax professional can guide you through the legal and financial side of things, and it can feel like there are endless demands on the finances of the estate, there is an area where we can help. At Aura, our expertise lies in helping you make a decision that feels right for you when it comes to how you will remember your loved one. We have guides that can help you compare funeral plans and direct cremation providers so that you feel supported when making one of the most emotional decisions you may be faced with at this time.
We know that talking about money and assets can feel stressful at the best of times, especially when you add in the fact that a loved one may be approaching the end of their life. While these conversations are seldom easy, having them early may allow you all to find a sense of balance in life and can help mitigate some of the stress and upset that understandably occurs when a loved one dies.
We hope you have found answers to your queries, perhaps even some words of support, in our guide. If you would like to explore the complex world of inheritance tax on gifts further, you may find it helpful to speak with a tax planning professional who will be happy to guide you through your options. We can also recommend services such as Cruse Bereavement Support that you may find helpful if you are facing difficulty in your grief, and feel you want to open up to someone outside of your family and friends.
Giving a gift is something that many tax planning professionals will recommend as a way of minimising your tax exposure. Because of the complex nature of the tax system, there is no definitive answer to the exact amount of tax you will pay because every situation has a variety of complicating factors. A good case in point is the fact that you can end up being taxed after you die, even though you gave the gift when you were still alive.
Taper relief means that the amount of inheritance tax you are charged on the aforementioned gift may be less than 40%, but a tax planning professional will need to be consulted for the final value to be determined. They will also be able to tell you how things such as business relief can help you to pass an asset to someone else without having to pay inheritance tax.
If you live longer than 7 years after giving a friend or loved one a gift, and the gift is not part of a trust set up to minimise your tax exposure, you will not have to pay any inheritance tax. This is known as the 7-year tax rule, and it is in effect regardless of how big the gift is, who you have given it to, and the nature of the gift itself.
Because trusts complicate matters, you may find it helpful to speak to your tax planner to understand how the 7-year rule comes into play. They will be able to guide you through your options and can help you to structure your affairs in a way that minimises tax exposure while maximising what your loved ones will inherit. Many families find that having these conversations in good time can help reduce the stress when a loved one dies.
Leaving everything to your spouse or civil partner will ensure that you are 100% exempt from inheritance tax, regardless of how large or complex your estate is. The same is true if you decide to leave all of your estate to one or more charitable organisations.
Something you may wish to consider is using charitable giving to cap the amount of inheritance tax you will pay on the remainder of your estate. A common way to do this is to give 10% of your estate to a charity, which in many cases will then cap the amount of inheritance tax that you pay on the rest of your estate at 36%. That said, because of the complex nature of the UK tax system, there are exceptions to this general rule that a professional tax planner may need to make you aware of.
Generally speaking, HMRC’s guidance is that you will not have to pay inheritance tax if your estate is worth less than £325,000. The same is very likely to be true if you leave an estate that is larger than this amount to a charity or your married partner. There are also instances where leaving your estate to a local community amateur sports club can grant you the same form of exemption.
Others choose to legally minimise their inheritance tax liability by actively reducing the size of their estate. Making gifts in the form of money and assets from your estate to friends and loved ones will help you reduce the value of your estate while you are still alive. Provided this is done in the right way with help from a professional tax planner, it can help you gradually pass your estate to your relatives in a way that is tax-free.
Another approach is to place some or all of your estate in a trust where one party administers the trust and a second party benefits from it. These types of arrangements, while perfectly legal and compliant with UK tax regulations, are highly complex, and you may find that the best course of action is to consult a tax professional you trust.
If you die within 7 years of giving a gift to a friend or loved one, you may find that inheritance tax becomes due on the gift. The precise amount of tax — you may not even have any tax liability — will depend on the size and nature of the gift, when you gave it within the 7-year window, and who you gave it to. For example, gifts given via trusts will still be liable for inheritance tax.
Giving cash gifts to family members is a common way to strategically reduce the value of an estate. There is a tax-free annual exemption of £3,000 that can be gifted to one member of your family. Alternatively, you may choose to split the £3,000 annual exemption between two or more relatives. Making use of your annual exemption each year can help you take a strategic approach to minimising the tax liability of your overall estate.
A trust is a complex financial instrument that needs to be set up by a tax professional, but understanding the basic principle of how they work may help you feel more comfortable with the options you have at your disposal.
The trust can help to protect your estate from inheritance tax by creating a divide between who legally owns the estate and who benefits from the value of the estate. The trustee is the person who legally owns and runs the estate, while the beneficiary is the person or persons who benefit financially from the way the estate performs over time.
Reporting taxable gifts to HMRC is a legal requirement and an obligation that a tax planning professional will help ensure you always meet. If you fail to report a taxable gift, you will be forced to pay anywhere from 50-100% of the undeclared tax. Something to have in mind here is that the person who receives the gift will be the one who is liable for the penalty. This means that incomplete tax structuring and inheritance planning may result in unwittingly increasing the stress and financial burden of a loved one.
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