Gifts made during your lifetime can reduce the value of your estate and so your IHT liability, provided you do not continue to benefit from the gifted assets.
If you do, this is typically deemed a ‘gift with reservation of benefit’, and is completely ineffective for IHT purposes (to stop people gifting away their home to children but then carrying on living in the property rent-free, for example).
Genuine gifts typically fall into one of three categories: immediately exempt transfers, potentially exempt transfers (exempt only if you survive seven years) and chargeable lifetime transfers.
Immediately Exempt Transfers
As well as the exemptions that apply to assets transferred to a UK domiciled spouse or civil partner, and to assets transferred to registered charities, community sports clubs and housing associations, to qualifying political parties, and to the ‘national interest’, the following lifetime gifts are also immediately outside of your estate for IHT purposes.
Normal gifts out of income
Those with surplus income can give this away on an immediately exempt basis, provided the gifts satisfy the following three criteria: gifts must be funded out of income rather than capital, must be part of a regular and habitual pattern of giving (rather than of a one-off nature) and must not affect the donor’s usual standard of living. This can be a particularly powerful exemption for those with large incomes, such as those who are still working.
Gifts in consideration of marriage or civil partnership
A parent can gift up to £5,000 to a child on (or shortly before) their wedding day on an immediately exempt basis. A grandparent (or great-grandparent) can gift up to £2,500, while others can gift up to £1,000 towards a marriage.
Gifts of no more than £250 to other individuals are immediately exempt (as long as you do not give the individual more than £250 over the whole of the tax year). You can give up to £250 to each of any number of beneficiaries on this basis.
In addition to the above, you can give away £3,000 each tax year on an immediately exempt basis. This is one of the most commonly used exemptions. If you do not use this exemption, you can carry it forward for one tax year only. Any carried forward exemption is only used once you have fully used the following tax year’s annual exemption.
Maintenance, education and training
Finally, as it can often be overlooked, expenditure on the maintenance, education or training of a child under age 18 (or over age 18 but still in full-time education) or the maintenance of any other dependant relative, such as an elderly parent, is usually immediately exempt too.
Rachel and John, a couple with three children and assets significantly in excess of their nil rate bands, make full use of their gift exemptions as follows:
- In the last 10 years of their career, having saved enough for their own needs, Rachel and John (as a couple) give £20,000 per year of surplus income to their three children. Over the 10 years, this removes £200,000 from their estate and saves up to £80,000 of IHT.
- Over their 30 year retirement, Rachel and John give £3,000 each per year (split between their three children). This removes £180,000 from their estate, and saves up to £72,000 of IHT.
- In their last 20 years, the couple also give £250 each per year to their four grandchildren and their four nieces and nephews. This removes another £80,000 from their estate and saves up to £32,000 of IHT.
- When each of their three children get married, they gift a further £5,000 each towards the cost of each wedding. These wedding gifts remove another £30,000 from their estate and save up to £12,000 of IHT.
All of these gifts are immediately exempt from IHT – there is no requirement that the couple live for another seven years.
Potentially Exempt Transfers
All other gifts to other individuals only become exempt from IHT if the donor survives for seven years after the gift is made. As such, these are known as ‘potentially exempt transfers’ (PETs). At the point of making the gift, no IHT will apply, no matter the amount given away. However, if the donor dies within seven years, a PET is said to ‘fail’ the seven year test, and becomes a chargeable transfer instead, on
which IHT may be payable.