Financial gifts – how helping loved ones could avoid an unnecessary tax bill

5 min read 4 Apr 23

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It’s common for family members to rally round and look at ways to help one another in difficult times. So, if your adult children or other family members are struggling to make ends meet as a result of the cost of living crisis, and you’re in a position to help out, you may be thinking about giving them money. But did you know that giving money to help those you care about could also help reduce your inheritance tax (IHT) liability?

This information is based on our current understanding of taxation law and practice in the UK which may change. The amount of tax you pay and relief you receive depends on your own personal circumstances which may also change in the future.

Many people only think about the financial legacy they could leave to their loved ones after their death. But helping out during your lifetime can be a way of making the most of your gift – giving those you love a greater sense of financial security in the here and now, while also potentially reducing your IHT liability at the same time.

This is because when you give money to friends or family – known as ‘gifts’ for tax purposes – you are decreasing the size of your estate (the value of everything you own) which can help reduce your IHT liability.

The aim of IHT planning is to reduce the value of your estate to bring it in line with tax-free allowances, reducing or even eliminating the amount of inheritance tax that will need to be paid.

When you consider that the average amount of inheritance tax paid was £216,000*, it shows just how important IHT planning is. Rather than hand over more than £200,000 in tax, wouldn’t you rather it go to your loved ones?

* Source: HMRC, 2019/2020 tax year.

But, before you make any decisions to gift money to loved ones, there are some important things you need to think about.

The timing of when you give a gift is crucial to how much inheritance tax, if any, might need to be paid after your death.

The rules on gifts are set out by HM Revenue and Customs (HMRC) and state that if the person making the gift passes away within seven years of giving the gift, there may be IHT to pay.

The chart below shows how the rate of tax due on gifts decreases over time, with the amount due at seven years or more being 0%:

Years between gift and death Tax paid
Less than 3 40%
3 to 4 32%
4 to 5 24%
5 to 6 16%
6 to 7 8%
7 or more 0%

This is why, if you’re able, it’s worth considering gifting as early as you can. This increases the possibility of you surviving for the next seven years and then reaching the 0% tax rate.

However, there are some exceptions to the seven year rule that you’ll want to remember.

Not all gifts are subject to the seven year rule. You can gift the following at any time without being subject to inheritance tax:

  • You can give up to £3,000 away each year exempt of IHT
  • You can give up to £250 per year to as many people as you like, but not if they’ve received the £3000 annual exemption
  • You can give gifts to charities, like museums or universities, and political parties
  • You can give wedding gifts of up to £5,000 for children, £2,500 for grandchildren or great-grandchildren and £1,000 for anyone else

You can also make regular payments to help another person with their living costs – these are known as ‘normal expenditure out of income’. Although there’s no limit to how much you can give tax free, this type of gift is more complex, as there are other rules that apply – a financial adviser can help you decide whether this type of gift is right for your personal circumstances.

Regardless of whether you’re taking advantage of one of the exceptions above, or gifting larger sums of money above the tax-free limits, it’s important to keep track of how much each person has received, and when.

To help avoid unnecessary pitfalls in the future, keeping records of the gifts you make is key, as whoever is managing your estate after your death may need to show evidence (for example, a bank statement).

Each time you give a gift, it might help to make a note of the information below and keep it with your other important papers:

Gift-giving checklist
  • Who the gift was given to
  • What gift they were given
  • The date the gift was given
  • The value of the gift

The rules around gifts and inheritance tax can be complicated. This article just scratches the surface. But, if you’re likely to be affected by IHT, the good news is that you don’t have to tackle this alone. An adviser can help you put an estate plan in place to help ensure your money will be passed on to your loved ones in the way that you wish. And having a plan can help reduce or possibly eliminate the tax that they might need to pay on your estate – meaning more of your hard-earned money can go to loved ones, rather than the taxman.

If you don’t have an adviser, you can find one that’s right for you.

This information is based on our current understanding of taxation law and practice in the UK which may change. The amount of tax you pay and relief you receive depends on your own personal circumstances which may also change in the future.

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