Gifting your assets to your family can be one way to reduce your estate and limit a potential inheritance tax bill.
However, the rules around gifting can be complex. In some cases, simply gifting an asset isn't enough to remove it from your estate. Below, we explore what inheritance tax is and how you can incorporate gifting into your financial planning.
What is inheritance tax and should you worry about it?
Inheritance tax is paid on a person's estate after they die at a rate of 40% tax, usually only on the value of the estate above £325,000. That said, there are exemptions and ways to increase this limit.
For example, if you're married or in a civil partnership, you can pass on your estate to your partner tax-free. Your spouse or civil partner can also receive your unused inheritance tax nil-rate band, giving them a total tax-free threshold of up to £650,000 in the event of their death. An individual's inheritance tax nil-rate band is normally £325,000.
In addition, if you own your house and you plan to give it to a direct descendant (i.e. a child or a grandchild), you get an extra £175,000 allowance, known as the Residence Nil Rate Band (RNRB) which you can also pass on to your spouse or civil partner if it isn't used when you die. In total, between the two of you, you could therefore theoretically leave your children £1,000,000 worth of assets (including property) tax-free.
That said, if you think your estate is likely to surpass the figures mentioned, there are ways to mitigate your tax burden. Financial planning is a complex field, so it's worth booking a free, no-obligation consultation with an inheritance tax adviser* via our website if you have any questions.
How gifts can lower your inheritance tax bill
Gifting your assets can reduce your estate and therefore lower your inheritance tax bill. However, in certain cases your gifts will count towards your estate, so it's important you understand the rules around gifting. This includes concepts like the 7-year rule as well as the special rules around gifting property and other assets where you're still deriving a benefit of some sort.
What is the 7-year rule?
The 7-year rule states that your beneficiaries will not need to pay inheritance tax (or any other type of tax) on gifts as long as you live for 7 years after you've gifted them. These gifts are known as potentially exempt transfers (PETs) as they only become fully exempt from inheritance tax if you live for 7 years after gifting them.
However, there's inheritance tax taper relief on gifts if you die within 7 years. So, for example, if you die within 3 to 4 years of making the gift, then 32% inheritance tax will be due on your gift whereas if you die 6 to 7 years after making the gift, then 8% inheritance tax will be due on your gift.
To make sure your family can make use of the 7-year rule, you should keep records of the gifts you've given, their value, who you've given them to, as well as when you've gifted them. These records can then be used as evidence when valuing your estate and calculating the inheritance tax bill after you die.
What gifts are exempt from the 7-year rule?
In some cases, gifts you make will be exempt from the 7-year rule. This means that even if you die within 7 years of making a gift, the gift won't count towards your estate for inheritance tax purposes. The gifts exempt from the 7-year rule include:
- Gifts up to £3,000 per year - You can gift family or friends up to a total of £3,000 per year without triggering a potential inheritance tax liability. Any part of your allowance you haven't used up the previous tax year can be carried over for a maximum allowance of up to £3,000.
- Small gifts (up to £250) - You're able to give up to £250 per person in small gifts each year to as many people as you like as long as you have not used your other allowances on them.
- Birthday or Christmas gifts - Gifts you give someone for their Birthday or Christmas are exempt so long as they come from your regular income.
- Tax-free wedding gifts - You're entitled to give someone who's getting married an inheritance tax-free wedding gift on top of your £3,000 allowance. You can give your child a £5,000 wedding gift, your grandchild or great-grandchild a £2,500 wedding gift, and up to £1,000 to any other person.
- Regular gifts from your surplus income - You're entitled to give regular gifts out of your surplus income provided you're able to sustain your standard of living. For instance, you might pay your adult child's rent, or your grandchild's school fees. There is no limit to how much you can give under this exemption, and it can be combined with your other allowances too. Regular gifts exemption can be a valuable way to reduce your inheritance tax bill (as there is no limit to how much you can give away), but it does come with certain criteria that must be met including the fact that the payments need to come from your regular monthly income after tax and that they're considered normal expenditure that you usually pay out on a regular basis (i.e. your adult child's rent, helping with living costs for an elderly relative). Also not all income types qualify. Pension income, interest on savings, rental income, dividend income qualify but not income from life insurance bonds. Typically, if you want to use this exemption, it's best to consult with a financial adviser first as the rules around it can be complex.
Can you gift your child your home?
You can gift your child your home but you it will continue to count towards your estate for inheritance tax purposes if you continue to derive benefits from the gift. So, for example, if you gift your child your property but continue living there without paying rent, this would be seen as deriving a benefit from the property and as such it would count towards your estate when you die even if you have given it away.
This is what is known as a gift with reservation.
To avoid this and endure that the gift of the property does not incur inheritance tax, you need to:
- Move out completely and live for at least another 7 years or
- Stay in the property and pay rent at the market rate and survive for at least another 7 years
In both cases, you won't be seen as deriving a benefit from the property as you will either live elsewhere or you will be paying the same amount of rent that anybody else would pay to live in the property.
Gifting your child your property can therefore make sense from an inheritance tax perspective. However, it will only work in certain circumstances, for example, if you're planning on moving abroad for retirement and living in a property you own there, or if you are happy to pay market-rate rent to your children. Bear in mind that with the latter option, the rent you pay will count towards their income and therefore they will need to pay income tax on the money they receive.
Should you gift to lower your inheritance tax bill?
Gifting can be an effective way to reduce your estate and therefore lower your inheritance tax bill. It's also a way to gift your children and grandchildren part of their "inheritance" early, allowing them to fund things like further education or a house deposit.
That said, there are rules around gifting when it comes to inheritance tax. If certain conditions aren't met, you might find your gift is still counted within your estate even if it's not technically yours. As such, it's a good idea to make sure you're familiar with the rules and ideally speak to a financial adviser about inheritance tax planning to ensure you're fulfilling all the requirements necessary to avoid inheritance tax. You can request a free, no-obligation consultation with an inheritance tax adviser* via our this form.
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