How Much Can I Gift Each Year to Avoid Inheritance Tax?

One of the most important considerations when planning your estate is minimising inheritance tax (IHT) for your loved ones. Inheritance tax can significantly reduce the wealth passed on to your heirs, but with careful planning, there are ways to mitigate its impact. One of the most effective methods is through gifting. But how much can you give each year without incurring inheritance tax?

This blog will guide you through the rules on gifts, annual exemptions, and other strategies to avoid inheritance tax while ensuring your estate is well-managed for future generations.

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What is an inheritance tax?

Inheritance tax is a tax paid on the value of a person’s estate after their death. In the UK, the threshold for inheritance tax (IHT) is £325,000, known as the nil-rate band. If the value of your estate exceeds this threshold, the excess is subject to a 40% tax rate. However, several reliefs and exemptions can help reduce or even eliminate the amount of tax paid.

Gifting is one such strategy. When done correctly, it allows you to transfer wealth during your lifetime without being subject to inheritance tax.

What are the rules for gifting?

Gifting rules in the UK provide several ways to pass on money or assets to loved ones without incurring inheritance tax. Let’s break them down:

• Annual exemption for gifting

  Each tax year, you are allowed to give away up to £3,000 free from inheritance tax. This is known as the **annual exemption**. If you do not use the entire £3,000 in one year, you can carry over the unused portion to the following year, but only for one year. For example, if you gave £1,500 in one year, you could carry over the remaining £1,500 to the next year, giving you a total of £4,500 to gift free of IHT.

• Small gift allowance

  In addition to the annual exemption, you can make small gifts of up to £250 per person each tax year. You can give as many small gifts as you like, but you cannot give more than £250 to the same person if you’ve already used another allowance for them. For example, if you’ve used part of your annual exemption to give £3,000 to your child, you cannot give them an additional £250 using the small gift allowance.

• Wedding or civil partnership gifts

  You can make tax-free gifts to family members for weddings or civil partnerships. The amount depends on your relationship with the couple:
  £5,000 to your child
  £2,500 to your grandchild or great-grandchild
  £1,000 to any other person

  These gifts must be made before the wedding or civil partnership, and the event must take place for the exemption to apply.

• Gifts out of surplus income

  Another lesser-known exemption is for gifts made out of surplus income. These are gifts you can give regularly without affecting your standard of living. There is no upper limit to these gifts, but they must be part of your normal expenditure. For example, regular contributions to help a grandchild with school fees could qualify, as long as they come from your surplus income and not your capital.

To qualify, you must keep records showing that the gifts were part of your normal expenditure and that they didn’t reduce your standard of living.

The seven-year rule: Potentially Exempt Transfers (PETs)

Larger gifts that don’t qualify for the annual or other exemptions may still avoid inheritance tax, but only if you live for at least seven years after making the gift. These are known as “Potentially Exempt Transfers (PETs)”.

If you die within seven years of making a gift, the gift becomes part of your estate, and IHT may be payable. However, the amount of tax payable depends on when the gift was made:

• If the gift was made within three years of death, the full 40% tax applies.
• Gifts made between three and seven years before death benefit from  “taper relief”, which reduces the amount of tax owed.

Here’s how taper relief works:

This means that the longer you survive after making the gift, the less tax will be owed.

Gifting to spouses and civil partners

One of the most effective ways to avoid inheritance tax is by gifting to your spouse or civil partner. Transfers between spouses or civil partners are completely exempt from inheritance tax, both during your lifetime and after death, as long as they are UK-domiciled.

This exemption allows you to pass your entire estate to your spouse or civil partner without any tax implications. Additionally, if you leave your estate to your spouse or civil partner, their IHT allowance will be added to their own when they pass away. This means the surviving partner could benefit from a **combined threshold of £650,000** before inheritance tax is due.

Gifting to charities

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Another way to avoid inheritance tax is by gifting to registered charities. Charitable donations are exempt from IHT, and if you leave at least 10% of your estate to charity, the rate of inheritance tax on the remainder of your estate could reduce from 40% to 36%.

This can be an excellent way to reduce the tax burden on your estate while supporting causes that are important to you.

What gifts are subject to inheritance tax?

Not all gifts are exempt from inheritance tax. Large, one-off gifts that don’t fall under the allowances mentioned above may still be liable for tax if you pass away within seven years of making them. These gifts become part of your estate and are subject to the *nil-rate band* and IHT, depending on when they were made.

Gifts made within three years of death are subject to the full 40% tax rate, while gifts made more than three years before death may benefit from taper relief, as previously discussed.

Keeping records of gifts

To ensure your gifts qualify for IHT exemptions, it’s essential to keep detailed records. These records will be crucial in proving that your gifts were within the allowed limits and were part of your normal expenditure if you’re using the surplus income exemption.

Make sure to record the following:

• Date of the gift
• Amount of the gift
• Recipient of the gift
• Purpose of the gift (if applicable, such as a wedding gift)
• Evidence that the gift was part of normal expenditure (if using surplus income)

This record-keeping can help your executors manage your estate more easily and ensure that no unnecessary tax is paid.

Gifting strategies to consider

When it comes to estate planning, it’s essential to have a strategy in place for gifting. Here are a few tips to consider:

• Use your annual exemption every year: Take advantage of your £3,000 annual exemption each year. By regularly gifting, you can reduce the size of your estate and minimize the inheritance tax payable by your heirs. Remember, if you don’t use your annual exemption in one year, you can carry it over to the next, but only for one year.
• Make regular gifts out of surplus income: If you have a steady income and can afford to make regular gifts, consider gifting out of your surplus income. This not only reduces the size of your estate but also allows you to give to your loved
  ones during your lifetime without being subject to IHT.
• Plan for large gifts early: If you’re planning to make significant gifts, it’s best to do so as early as possible to benefit from the seven-year rule. The sooner you make the gift, the less likely it will be subject to inheritance tax.
• Consider gifting to charity: Leaving at least 10% of your estate to charity can reduce the inheritance tax rate on the remainder of your estate from 40% to 36%. This can significantly reduce the tax burden on your heirs while supporting a cause that is important to you.
• Gifting property: If you’re considering gifting property to your children or grandchildren, be aware that property is subject to the same inheritance tax rules as cash gifts. If the value of the property exceeds the annual exemption, it will be subject to the seven-year rule and taper relief.

Conclusion

Inheritance tax can be a complex and emotional issue, but with the right planning, it’s possible to significantly reduce the tax burden on your estate. Gifting is one of the most effective ways to achieve this, allowing you to pass on wealth to your loved ones during your lifetime without incurring unnecessary tax.

Remember to use your annual exemption, make regular gifts out of surplus income, and keep detailed records of all gifts made. By doing so, you’ll ensure that your estate is managed efficiently and that your loved ones benefit from your generosity without facing a hefty tax bill.

If you’re unsure about the best gifting strategy for your estate, it’s always a good idea to seek advice from a financial planner or tax specialist. They can help you navigate the rules and ensure that your estate is protected for future generations.