A tax expert has explained a key rule for anyone who wants to gift money to children and grandchildren without being hit with inheritance tax. Alterations to inheritance tax legislation, which are taking effect next year, have prompted people to rush to explore particular ‘gifting’ arrangements they can utilise to prevent it being diminished by taxation, it was reported.
Changes to pension taxation
From April 2027, any pensions remaining after someone dies will be liable for tax. BBC Radio 4 show Moneybox reported that the change was also prompting people to review their inheritance tax liabilities in general and work out how to pass on money to relatives without being stung by tax.
Presently, upon death, individuals can typically transfer up to £325,000 (the nil-rate band) without taxation, increasing to £500,000 when bequeathing a primary residence to descendants. Unlimited wealth can be transferred to a spouse or civil partner, or to a charitable organisation, entirely exempt from Inheritance Tax (IHT), with any unused allowances transferable.
How gifting allowances work
A married couple can bequeath up to £1 million tax-free - comprising two £325,000 tax-free allowances and two £175,000 main residence allowances. For this arrangement, the couple must be legally wed. Beyond this, the inheritance tax liability can be reduced through gifting.
Sarah Coles, head of personal finance at AJ Bell, explained how gifting works: “You can usually give away up to £3,000 each tax year without it counting towards your estate for inheritance tax purposes.”
“If you don’t use the allowance, you can carry it forward for one tax year. You can also make gifts of up to £250 to any number of people, provided they haven’t also benefited from your £3,000 annual exemption. Separate exemptions also apply for certain wedding gifts.”
Tax-free thresholds and rates
On the overall tax, she said: “Everything left to your spouse is inheritance tax-free. Anything you leave to your spouse or civil partner is generally exempt from inheritance tax. This applies to married couples and civil partners and covers assets passed between them.”
“You have two nil rate bands. Up to £325,000 can usually be left to someone other than a spouse or civil partner free of inheritance tax through the standard nil rate band.”
“On top of that, many people can also benefit from the £175,000 residence nil rate band if they leave their main home to direct descendants, including children, stepchildren and adopted children. Together, these can allow up to £500,000 of an estate to be passed on tax free.”
Above the thresholds, the standard inheritance tax rate is 40%, unless other reliefs apply.
Seven-year rule and surplus income
In addition to the gifting rules, people can also send larger sums, but these are subject to the seven-year rule. Ms Coles said: “You can give away larger lump sums, known as potentially exempt transfers (PETs).”
“If you survive for seven years after making the gift, it normally falls outside your estate for inheritance tax purposes. If you die within seven years, some or all of the gift may still be taken into account when calculating inheritance tax.”
There is also money from ‘surplus income’. Ms Coles said: “Regular gifts made from surplus income can also fall outside your estate, provided they meet HMRC’s rules.”
“The gifts must come from income rather than savings, leave you with enough income to maintain your usual standard of living, and form part of a regular pattern. Keeping detailed records is essential.”
The issue was previously discussed on the Martin Lewis podcast, and he asked Lucie Spencer from Evelyn Partners to go through all the available gift allowances. He said: “There’s a £3,000 rule isn’t there?” Lucie explained: “So there’s the large gift allowance, which is £3,000 per individual per tax year. And what that means is I can give £3,000, my large gift allowance, either to one person or split between multiple people and also I could reclaim a tax year as well, so if you haven’t given that £3,000 in the last tax year, you can effectively give £6,000 today.”
Martin queried: “So this is so people understand. This is outside of the seven-year rule. Outside of the giving-money-from-surplus-income rule. You, as an individual, can give up to £3,000 per tax year without paying inheritance tax. How do you denote that you’re using this large gift allowance? Do you have to note down that’s what your intention was or is it just back count?”
Lucy advised: “I recommend with all gifts and that’s the small gift allowance of the £250, the large gift allowance of the £3,000 or any gifts are written down on a piece of paper or a spreadsheet and held with your will because when someone passes away and you come to complete their inheritance tax form there’s actually a whole list where you have to detail all of the gifts which you’ve made leading up to your death.”
“So definitely make a note of it and put it in one column and put ‘large gifts allowance for this tax year.’”
