We would all like to make gifts to our loved ones and often people would prefer to make such gifts during their lifetime, rather than after their death, so that they can witness the recipient’s enjoyment of receiving the gift.
Lifetime gifting can also be a very effective way of reducing the value of a person’s estate to mitigate the Inheritance Tax payable on their death. However, Inheritance Tax may still be payable after your death, on gifts made during your lifetime.
What is the Legal Definition of a Gift?
The following are all considered gifts:
- Household and personal goods;
- A house, land or buildings;
- Money;
- Stocks and shares;
- Money representing the difference between the market value of an asset and the value for which it was actually sold e.g. selling a house to a child for an undervalue.
Does it matter when I make the Gift?
Yes, timing is important. If you survive the making of a gift by 7 years, then it falls outside of your estate for Inheritance Tax purposes. In other words, the value of the gift is no longer considered part of your estate, on which your estate could pay Inheritance Tax. This is referred to as the “seven year rule” and the gift is a “potentially exempt transfer.” However, if you die within 7 years of making a gift and there is Inheritance Tax to pay (after all other available allowances have been applied), then the amount of Inheritance Tax payable by your estate will depend on the timing of the gift.
- Gifts made in the 3 years prior to death are taxed at 40%.
- Gifts made within 3 to 7 years prior to death are taxed on a sliding scale referred to as taper relief. Taper relief only applies if the total value of gifts made in the 7 years before death is over the Inheritance Tax free threshold of £325,000.
- 7 years or more 0%
- 6 to 7 years 8%
- 5 to 6 years 16%
- 4 to 5 years 24%
- 3 to 4 years 32%
- 3 years or less 40%
Why is it important who receives the gift?
Some gifts are exempt from Inheritance Tax, depending on who is the recipient of the gift.
Gifts made to Charities and political parties are exempt from Inheritance Tax. As too are gifts between spouses and civil partners, regardless of the amount or timing of the gift, provided they are a permanent UK resident. These are exempt beneficiaries and there is no limit as to how much can be gifted or when the gift can be made.
What if I make a gift but still benefit from the asset gifted?
If you give away an asset but retain the benefit from it, such as gifting your house to a child but continue to live there, then the value of the gift will be included in the value of your estate, on which Inheritance Tax may be liable. This is known as a “Gift with Reservation of Benefit”.
How much can I give away?
During our lifetime we can each give away a total of £3,000 of gifts each tax year to non-exempt beneficiaries, without paying Inheritance Tax. This is known as the “annual exemption”. In other words, those gifts are not added to the value of your estate when calculating the Inheritance Tax due. The gift does not have to be one gift to one person, it could be split between several people. The total gift/s must not exceed £3,000 to fall within the annual exemption.
Any unused annual exemption can be carried forward to the next tax year, but only for one year giving a maximum of £6,000 in that tax year.
Can I make small gifts?
You can give as many small gifts of up to £250 per person to as many people as you choose each tax year. You cannot give a gift or more than £250 and avoid paying Inheritance Tax on the first £250. Inheritance Tax would be payable on the whole amount. The small gift allowance cannot be used if you have used any other allowance on the same person.
Can I make regular gifts or payments?
You can make regular payments to another person free of Inheritance Tax, such as helping a child with their rent or mortgage, paying into savings account for another, financially supporting a relative etc, if the payments can be made from surplus income. These payments must not be made from savings. Such payments are exempt from Inheritance Tax as “normal expenditure out of income”. There is no limit as to how much you can give provided you can afford the payments after meeting your usual living costs and you make the payments from your regular monthly income.
Birthday and Christmas gifts and other customary gifts are exempt from Inheritance Tax if they are made from your regular income.
You can combine normal expenditure out of income with any other allowance, except the small gift allowance.
Can I make a wedding gift?
Each tax year you can give a gift to someone who is getting married or starting a civil partnership. The amount depends on your relationship to recipient. You can gift £5,000 to a child, £2,500 to a grandchild or great grandchild and £1,000 to any other person.
You can combine a wedding gift allowance with any other allowance, except the small gift allowance.
An interesting point to note is that if you make a wedding gift and the wedding is subsequently called off the gift would no longer be exempt from Inheritance Tax.
Who pays the Inheritance tax on gifts?
Inheritance Tax on gifts is usually paid by the estate, unless you have gifted more than £325,000 in the 7 years prior to your death. If you have gifted more than £325,000 in the 7 years prior to your death, the recipient of the gift will be liable for the Inheritance Tax due on it. This could cause a very unintentional problem for the recipient of the gift who may not have been aware at the time the gift was received that Inheritance Tax would become payable.
Should I keep records of gifts made in my lifetime?
Yes absolutely. When you pass away the Personal Representative/s will need to know about the gifts made in the seven years prior to your death to be able to apply any available exemptions, calculate any Inheritance due, report the gifts on the relevant Inheritance Tax Return (if necessary) and ensure the correct Inheritance Tax is paid (if applicable).
If you keep records so that the necessary information is available to the Personal Representatives, this could save the estate both time and costs in attempting to determine such gifts.
Another point to consider is that keeping records of the gifts you make will allow you to notify the recipient of the gift that Inheritance Tax may become payable on your death, if applicable.
Gifts you can make
Here is a summary of the gifts you can make without paying any Inheritance Tax (subject to them meeting the criteria set out above:
- Gifts within the annual exemption
- Small gifts
- Wedding gifts
- Gifts to a spouse or civil partner
- Gifts to charities and political parties
- Normal expenditure from income such as living costs.
Please be aware that all values and percentages quoted in this article are correct at the time of publication. Values and percentages are subject to change, therefore we recommend you discuss your personal circumstances with us in order to receive the most up to date advice.
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