Wealth advisers often encourage clients concerned about inheritance tax to give “with a warm hand rather than a cold one”. The message is simple: nothing — not even fancy family trust planning — is as effective as gifting to shrink your estate before it falls under the watchful eye of the tax authorities.
In the past tax year, HM Revenue & Customs collected £8.25bn in IHT, a 10 per cent rise on the previous tax year. By 2029-30 that’s expected to rise to £14.3bn, due to frozen thresholds and tax on pensions.
There’s an understandable reluctance to give too early in retirement. These are the “go-go” years, when you’re enjoying the benefits of everything you’ve strived for through work. The last thing you’re going to do is start giving it away immediately, unless there is a pressing reason. In the wake of VAT on private school fees, more grandparents are funding their grandchildren’s education, for example.
But usually, people don’t start gifting at 60, they wait until their late 70s and 80s, says Doug Brodie of Chancery Lane Retirement Income Planners. “This is when you know ‘that money’ is not likely to be needed, and you really accept that everything is going to be passed on anyway,” he says.
The problem is the gifting rules are very complex. Independent research conducted among “mass affluent” consumers for Charles Stanley — defined as those earning above the UK average pre-tax salary (£33,000) and with at least £1,000 in accessible cash or savings — found many wealthier people could be falling foul of the rules, due to a lack of understanding. In fact, 27 per cent said they didn’t even know there are gifting rules.
There’s been confusion among consumers since the gifting limits were introduced in the 1980s. Back in 2019, Bill Dodwell, tax director at the now- defunct Office for Tax Simplification, declared: “The taxation of lifetime gifts is widely misunderstood and administratively burdensome.” The OTS’s sensible recommendations included replacing the multiplicity of lifetime gift exemptions with a single personal gift allowance.
Six years later there’s no sign of HMRC simplifying the rules (and the OTS is no more). What’s bizarre, is that exemptions relating to lifetime gifts haven’t changed for 40 years — not even to keep pace with inflation.
So what are they? In short, every year you are allowed to give any value to a spouse or partner, or up to £3,000 to anyone else — and if you didn’t use it in the past tax year, you can carry it forward and give £6,000. You can also give unlimited small gifts of £250 each to anyone. And you can give wedding gifts (up to £5,000 for a child).
Beyond this, any gifts are “potentially exempt transfers”, subject to IHT if given in the seven years before death, the rate of which tapers as you get closer to that limit. If you’re 80 with an average life expectancy of 9.53 or 8.12 years — depending on whether you’re female or male — the worry is that this might not work out.
Charles Stanley found that knowing the limits can lead to a “too cautious” approach. But significant numbers are gifting away blithely because they think “inheritance tax is not their responsibility”.
They’re potentially storing up a big financial hit for children or other beneficiaries, who may have spent the money received before receiving an unwelcome IHT bill.
To avoid this what can you do? I’d start by making an effort to use the annual gifting limits. They may not be as significant as they used to be — Quilter calculates that if the £3,000 annual allowance had tracked inflation since 1981 it should now be over £11,000 — but they still amount to savings worth having.
Investment platform Interactive Investor calculates that using your £3,000 annual gifting allowance over seven years could save £7,200 in IHT vs gifting a lump sum of £21,000 that is taxed at the full 40 per cent. Married couples and civil partners can “double up” by each using their allowances.
But it’s the little-known “gifts out of income” rule that can really deliver, because it has no limit to what you can give tax free. Did you know that any gifts given from surplus income (income not spent on living costs) are immediately excluded from your estate for IHT purposes — even if you die within seven years?
Yet this powerful rule is very underused — only 430 families claimed this exemption in the 2022—23 tax year.
Perhaps that’s because HMRC’s guidance is vague? The gov.uk website states: you must be able to afford the payments after meeting your usual living costs; and you must pay the gifts from your regular monthly income. If you’re giving gifts to the same person, you can combine “normal expenditure out of income” with any other allowance, except for the small gift allowance.
But “normal” is not defined. Some advisers point out that HMRC advises its officers to consider a time span of three to four years to determine whether there is a regular pattern of gifts. A single gift may qualify as normal expenditure if it is intended to be the first in a regular pattern.
Write the recipients letters of intention as evidence and keep detailed records to prove the gifts were made from surplus income. The records will be needed when it comes to administering your estate and claiming the exemption. Some advisers even encourage clients to fill out the IHT403 gifts and transfers of value form themselves, which beneficiaries of inheritances would have to complete after their death.
Ian Dyall, head of estate planning at wealth management firm Evelyn Partners, politely describes meeting these rules as “finicky”. Importantly, the gift must come from income like employment, pensions, rent, interest or dividends. You’re not allowed to dip into “capital” or savings. This can be a grey area, as income does not retain its status as income indefinitely: it will at some point become capital.
In the case of pensions, Dyall warns: “What you can’t do is take all your tax-free cash, stick it in a bank account and gift it gradually from there, as then it will be seen as a gift from capital and not from income.”
HMRC is yet to publish its response to the inheritance tax on pensions technical consultation that ended in January. But unused pensions are set to be subject to IHT from April 6 2027, so the earlier gifting starts, the better, to stop your family being landed with a big IHT bill after you die. Despite the complexity, it’s time to make someone’s day.
Moira O’Neill is a freelance money and investment writer. Email: moira.o’neill@ft.com, X: @MoiraONeill, Instagram @MoiraOnMoney
