Gifts and exemptions from Inheritance Tax

But if a husband’s estate is £300,000 and he left it all to his brother, his wife would only be entitled to the remaining unused part of the nil rate band, which is £25,000.

Gifts to an unmarried partner might mean you have to pay Inheritance Tax.

What and how much you wish to give your children or other members of your family is completely up to you.

But to ensure that it’s tax-free, it’s important to plan when to make that gift.

Simply put, so long as you live for more than seven years after you make this gift, your children or family won’t have to pay Inheritance Tax on your gift when you die.

However, any income or gains made from this gift could have tax implications for the beneficiary, for example, Capital Gains Tax.

But if you don’t live more than seven years after you’ve made the gift, they might have to pay Inheritance Tax.

When the gift is first made, it’s called a Potentially Exempt Transfer as, assuming you live for a further seven years, there won’t be any IHT due on it. If you die within seven years, it’s called a Chargeable Transfer.

This means if you’re thinking about giving away money or assets to your family and friends to reduce Inheritance Tax, it’s very important you make a record of:

• what you gave
• who you gave it to
• when you gave it
• how much it’s worth.

This will make it easier for the executor of your estate to work out during probate what parts of your estate are liable for tax.

To encourage more people to leave money to charity, any cash or physical asset you leave to a qualifying charitable body, either during your lifetime or in your will, would be exempt from Inheritance Tax (IHT).

This can also reduce the rate at which IHT is due from the current rate of 40% down to 36%. This reduced rate would only apply if the value gifted to charity amounted to at least 10% of the ‘net estate’ at the date of death. This potentially saves thousands of pounds.

Generally, the net estate is defined as the value left over after deducting any exemptions (including your available nil rate resident band) and any other available reliefs.

This can be quite a complex area and you may want to get professional advice to be sure any gift you make will qualify.

While you’re alive, you have a £3,000 ‘gift allowance’ a year. This is known as your annual exemption.

This means you can give away assets or cash up to a total of £3,000 in a tax year without it being added to the value of your estate for Inheritance Tax purposes.

Any part of the annual exemption which isn’t used in the tax year can be carried forward to the following tax year. It can only be used in the following tax year and can’t be carried over any further.

Certain gifts don’t count towards this annual exemption. As such, no Inheritance Tax is due on them.

Gifts worth more than the £3,000 allowance in any tax year might be subject to Inheritance Tax.

You can give as many gifts of up to £250 to as many individuals as you want. Although not to anyone who has already received a gift of your whole £3,000 annual exemption. None of these gifts are subject to Inheritance Tax.

Gifts to help pay the living costs of an ex-spouse, an elderly dependant or a child under 18 or in full-time education might be exempt.

A Potentially Exempt Transfer (PET) enables an individual to make gifts of unlimited value which will become exempt from Inheritance Tax (IHT) if the individual survives for a period of seven years.

If you don’t survive the gift by seven years, the PET becomes a Chargeable Consideration, and is added to the value of your estate for IHT. If the combined value is more than the IHT threshold, IHT may be due.

Any lifetime transfer that is Potentially Exempt must meet certain conditions subject to certain exceptions. The transfer is a gift made by an individual to another individual or to a specified trust. This means, for example, the gift cannot be made from or to a corporation or company.

For example, if a gift of £400,000 is given:

1. The gift will initially use up the available NRB of £325,000 (oldest gifts are attributed first).
2. The remaining £75,000 on death is then subject to IHT (in addition to IHT on the estate).
3. If the remaining £75,000 was given over three years before the death, taper relief may apply.
4. For example, if the whole gift was made between three and four years before the death, the tax charge on the £75,000 would be 32%.
5. So IHT due on the PET would be £24,000.

Gifts where you still have an interest in it, no matter when you’ve given it, don’t qualify as a PET.

For example, if you continue to live rent-free in the house you gave your child more than ten years ago, the house would still be considered part of your estate and therefore subject to IHT. This is known as a gift with a reservation of benefit.

If there’s Inheritance Tax (IHT) to pay, it’s charged at 40% on gifts given in the three years before you die. Gifts made three to seven years before your death are taxed on a sliding scale known as Taper Relief.

The table above shows the reduction in IHT tax that would otherwise be payable on the transfer.

Taper Relief doesn’t reduce the value of the gift transferred – it only reduces the tax payable.

• Agricultural property — you can pass on a farm free from Inheritance Tax, if as it meets certain conditions. But certain farm assets aren’t exempt from tax, such as farm machinery. Also, if a non-qualifying asset, such as farm equipment, is used in business, it might qualify for Business Relief. 

• Woodland property — you can get relief for growing timber, but it only applies to the timber, not on the land itself. It’s applied on death and defers the tax due until the timber has been sold. However, woodlands used for commercial purposes could get up to 100% Business Relief, which is preferable to deferment. In theory, Inheritance Tax can be postponed until the trees are cut and sold, provided the woodland has been owned for five years.

• Heritage assets — if you own a building, land, or objects of national scientific, historic or artistic importance, you could claim relief from Inheritance Tax. This generally only applies to stately homes, land of outstanding natural beauty, or famous works of art. There are certain conditions that must be met to get this relief.

• Some gifts depending on the value and when it was given.

Money, assets or property you put into a trust isn’t always exempt from Inheritance Tax.

It depends on the type of trust you choose to set up to hold the asset.

From April 2027, most unspent pension pots and death benefits will count as part of your estate when you die.

This means the value of your pension will be combined with other assets to determine if your estate owes Inheritance Tax.  

When you make your will, it’s always a good idea to plan your estate and what should happen to it when you die.

Making gifts and transfers in your lifetime is one way of planning your estate. It’s a good way of cutting your Inheritance Tax. But the law in this area is quite complex.

The same also applies to putting your assets into a trust for your family to inherit when you die.

It’s best to get advice from an expert in estate planning, such as a solicitor or an independent financial adviser.

To search for an estate and tax planning adviser in your area, use:

• the Retirement Adviser Directory — select ‘Inheritance Tax planning’ to refine your search results for firms that offer regulated advice in Inheritance Tax planning.