As the average inheritance tax (IHT) bill is now more than £200,000, and rumours continue about the government raising this tax in a bid to recoup some of the debt caused by the pandemic, it may be time to start thinking about your estate and making Potentially Exempt Transfers or gifts.
According to a new report from The Openwork Partnership, six in ten parents and grandparents intend to pass on money before they die. And the next generation is set to receive more than £293bn. Unfortunately, as it gets harder and harder to get on the property ladder, gifts like these can be instrumental in helping the younger generation take their next step in life.
Typically, we think of gift-giving as a time for celebration. Although, when it comes to giving financial gifts (or Potentially Exempt Transfers), it’s suddenly a whole different ball game. Giving away money that you’ve worked hard to build, as well as making sure you have enough, is a hard balance to strike.
But before you jump right into giving money away, you’ll need to know about the tax implications often overlooked. Consider this your complete guide with everything you need to know about financial gifts.
What are Potentially Exempt Transfers?
First things first, let’s explain the basics of what Inheritance Tax is. It’s the tax on the total value of someone’s possessions, property, and money when they pass away. IHT is payable at a rate of 40% on anything above £325,000 (your nil rate band) unless it’s passed to your spouse, civil partner, or charity.
So, when it comes to giving away money during your lifetime, HMRC usually has something to say about it. Some gifts are tax-free, which we explore in more detail below. However, if you’d like to make a significant gift, unfortunately, these aren’t automatically treated the same immediately.
To clarify, when we’re talking about gifts in this article, we’re talking about Potentially Exempt Transfers (or PETs), but as that’s a bit of a mouthful, let’s stick to ‘gifts’.
Potentially Exempt Transfers are gifts of unlimited value, which will eventually become exempt from IHT if the giver survives seven years. To be clear, you can make a gift to any person, of any amount, at any given time. It’s a transfer of anything that has value, such as possessions, property, or money.
If the gift is into a trust, then the rules are different. They are called chargeable lifetime transfers (CLTs), and immediately chargeable to IHT. As trust planning is very complicated, we suggest you contact a financial planner to discuss this in more detail.
The seven-year rule
When making Potentially Exempt Transfers, no tax is payable immediately, or if you survive seven years from the date of the gift.
However, as the name suggests, it’s only potentially tax-free. If you die within seven years, the transfer becomes chargeable.
If it’s a cash gift of less than £325,000 (your nil rate band) and you haven’t made other gifts in the last seven years, there is no tax for you or anyone else to pay. However, it would reduce the amount of your nil rate band available on your death.
If you die within seven years of making gifts exceeding your nil rate band, there won’t be any left for your estate to use. IHT also becomes payable on the amount over your nil rate band, and the recipient is liable for the tax. The amount of tax depends on how long you survive after making the gifts; gifts made within the 3 years of death are taxed at 40%, and between 3 – 7 years get taxed on a scale known as tapered relief.
The calculation requires careful thought and planning, so if you want to make any gifts, we suggest you contact a financial planner to discuss this in more detail beforehand.
Exceptions to the rule
Some gifts may immediately fall outside of your estate and won’t be regarded as Potentially Exempt Transfers at all.
Married couples or civil partners
Transfers between married couples or civil partners do not count as gifts (or Potentially Exempt Transfers) and are free of IHT, so long as they live in the UK and you are legally married or in a civil partnership.
Gifts to charity or political parties
If the gift is to charity or a political party, there won’t be IHT to pay. The standard inheritance tax rate is 40%. However, if you leave 10% or more of your net estate to charity, then the rate of IHT is reduced to 36%.
Payments by a parent towards their child’s maintenance or education
Payments by a parent towards child maintenance or education are not regarded as gifts and are therefore free from IHT if they are under 18 or in full-time education. This treatment does not apply to similar payments from grandparents.
Expenditure out of income
Regular gifts made from surplus income that do not affect your usual standard of living are immediately exempt and treated as having left your estate. They will not get added back in when you die.
Up to £3,000 can be gifted each year. And this again will not be added back to your estate when you die. If the previous year’s allowance is unused, you can carry this forward to make £6,000.
You can make any number of small gifts of up to £250 each year to different people.
Gifts in consideration of marriage
Each parent may gift up to £5,000 in consideration of marriage or civil partnership. For grandparents, the figure is £2,500. And for any other person, it is £1,000.
Start planning now
Estate planning is a very complicated and emotional area of financial planning, and making Potentially Exempt Transfers or gifts is just one of the ways you can minimise the IHT liability for your loved ones. We have previously explored the other options in more detail here.
Our top tip would be to start with an IHT calculator to give you an idea of the total value of your estate and how much inheritance tax may be due after you’ve gone.
Once you know this, you then need to start thinking about what you might need for the rest of your lifetime. After all, first, you need to look after yourself. Cashflow modelling can help with this.
It’s only then you can see how much you can afford to gift and the impact.
If you have any questions or want to discuss your financial plan, please feel free to get in touch with us and speak to one of our financial planners.
Later this month we will also host a webinar on Inheritance Tax Planning, so click here to register to join us to find out more.