Strategies to Reduce Inheritance Tax by Gifting

With inheritance tax (IHT) on the rise, here are some strategies to help you save on inheritance tax by making gifts to your children and / or grandchildren.

Understanding Inheritance Tax (IHT)

IHT is generally applied at 40% on the value of an estate above the £325,000 threshold. Additionally, there’s a potential allowance of up to £175,000 if you’re passing your family home to your children or grandchildren. Married couples or civil partners can often pass on up to £650,000 – or up to £1 million when including the family home.

Can Gifting Reduce Your IHT Bill?

Many people choose to give gifts to their grandchildren to help secure their financial futures. By making gifts now, you could potentially reduce the amount of inheritance tax that will be due later. Below are some of the ways gifting can help reduce your inheritance tax liability.

Please note, tax rules can change, and the effectiveness of these strategies depends on your circumstances and those of the recipient. Consider seeking financial advice if unsure.

Inheritance Tax Exemptions

Annual Exemption

You can give away up to £3,000 per tax year free from inheritance tax. This is referred to as the annual exemption. If you don’t use the full £3,000 exemption in a given year, you can carry over the unused amount to the following year, but only for one year.

For example, if you used £2,000 of your allowance last year, you could gift £3,000 in the current year, plus £1,000 carried over, totaling £4,000.

Small Gifts

Alongside the annual exemption, there is also a small gifts exemption. You can give up to £250 to as many individuals as you like each tax year. However, you can’t give a small gift to someone who’s already received a gift under a different exemption.

If you give more than £250 to one person, the exemption doesn’t apply. Additionally, wedding or civil ceremony gifts are exempt up to £5,000 for a child, £2,500 for a grandchild, and £1,000 for others.

Gifts Out of Income

You can also make ‘gifts out of income’ free from inheritance tax. These are regular payments made from surplus income, so long as they don’t affect your standard of living. This exemption can be useful if you want to contribute to a child’s investments through regular savings.

It’s important to keep records. If you choose to make regular gifts out of your income, keeping a record of your after-tax income will help show that these gifts are part of your regular spending and that you have enough income to cover both the gifts and your normal expenses.

Potentially Exempt Transfers (PETs)

If your gifts don’t fall under the exemptions, they are usually classified as Potentially Exempt Transfers (PETs). There’s no limit on how much you can gift as a PET, but the gift will only be exempt from IHT if you live for seven years after making it.

If you pass away within seven years of making the gift, it becomes chargeable for IHT. However, if you survive between three and seven years, taper relief can reduce the tax liability. The closer the gift is to the seven-year mark, the greater the reduction in tax.

Saving and Investing for Children

You might also consider saving or investing money for your grandchildren. While a standard savings account might seem like a safe option, inflation can erode the real value of savings over time. Cash is usually best for short-term goals, but for longer-term plans, investing in the stock market could potentially outpace inflation.

Remember, however, that investments carry risk, and unlike cash savings, the value of investments can go up or down, meaning the amount your grandchild receives could be less than you originally invested.

Planning ahead with gifting strategies and understanding how IHT works can help ensure that more of your wealth is passed on to your loved ones rather than being lost to taxes.

Consider Financial Advice

Inheritance tax planning can be complex, and professional advice can help clarify your options. If you need assistance navigating tax allowances or other aspects of inheritance planning, it’s worth considering consulting with a financial adviser.

Founded in 2017, Fintuity has fast become one of the only digital Independent Financial Advisers (IFA) in the United Kingdom.  Fintuity offers a wide range of financial advisory services including pensions, protection, investments and mortgage advice. The key difference is that as an exclusively digital service, we can offer significant savings and a service that is direct to you and on demand.