In England and Wales there is no limit to the amount you can give away during your lifetime, however, subject to the amount and timing of your gift, that gift may be counted as part of your estate on your death and potentially liable to Inheritance Tax. (If the value of your estate is over £325,000 (the Nil Rate Band), generally the value in excess of that threshold will be charged to Inheritance Tax, the standard rate of which is currently 40%.)
There are a number of Inheritance Tax exemptions available for lifetime giving. However, with a new government in place, some or all of these exemptions may be subject to change, with Inheritance Tax not being one of the few taxes ruled out by our new Chancellor as being safe from change.
In this article we will review the main exemptions still available to be used, some of the pitfalls of these exemptions and what the future may hold for this area of Inheritance Tax.
Inheritance tax gifting exemptions
An outright lifetime gift, made with no strings attached, is known as a “Potentially Exempt Transfer” (PET). It is potentially exempt (from Inheritance Tax), because whether it is counted as part of your estate or not on your death, depends on when the gift was made. If you survive seven years from making the gift, then it will drop out of your estate and be exempt from Inheritance Tax. However, if you die within seven years of making the gift, it will be counted as part of your estate (although the amount of Inheritance Tax on the gift can start to reduce after 3 years).
The main Inheritance Tax exemptions available which allows you to make lifetime gifts, within certain thresholds, that will be free of Inheritance Tax and will not be added to the value of your estate on your death, irrespective of how many years have passed, are as follows:
- Annual exemption: allows you to gift (to either one person or split between several people) up to a total of £3,000 each tax year, free of Inheritance Tax. If you do not use your £3,000 annual exemption, you can carry this forward one tax year.
- Small gift allowance: allows you to gift up to £250 per person (to an unlimited number of people) each tax year. You cannot use this allowance when making a gift to an individual that you have already used another exemption on.
- Normal expenditure out of income: this is a very useful exemption which allows you to make regular gifts to another individual, free of Inheritance Tax, as long as the gifting leaves you with sufficient income to maintain your normal standard of living. This exemption is currently uncapped in the amount you can gift.
- Gifts made in consideration of marriage or civil partnership: you can gift up to the following amounts, to someone who is getting married or entering into a civil partnership, and the amounts depend on your relationship with the recipient. You can gift up to:
~ £5,000 to a child.
~ £2,500 to a grandchild or great-grandchild.
~ £1,000 to any other person.
The gift can be combined with another exemption (but not the small gift exemption), such as the annual exemption to allow you to gift a larger amount. - Gifts between spouses or civil partners (living in the UK) and gifts to charities and political parties, are also exempt from Inheritance Tax.
The pitfalls of IHT gifting
The most common pitfall when trying to rely on one or more of these exemptions is poor record keeping. If accurate records have not been maintained during lifetime, on the giftor’s death, executors are often faced with the difficult task of sourcing information spanning 7 years before the death (or sometimes up to 14 years, if gifts have been made to trusts). Record keeping is especially essential if the normal expenditure out of income exemption is to be relied on – part of the disclosure on death includes setting out the deceased’s annual income and expenditure, for each year the exemption is being claimed, to show a surplus exists to cover the gifts made.
Some other pitfalls include failing to take into account the interaction between the different exemptions and making a gift of something that you still benefit from (contravening the “no strings attached” basis of PETs), to name a few.
Furthermore, many may not be aware that the Nil Rate Band is allocated to lifetime gifts first (in the order that they were made), with any balance remaining used against the rest of your estate. In addition, the initial liability for any Inheritance Tax payable on a lifetime gift, is with the recipient of the gift. Both these factors can result in potentially more or less being received in the hands of the recipient than was intended by the giftor.
What the future may hold for lifetime gifting
Although taxpayers may generally be wary of announcements to changes of tax regimes, some reform in the area of lifetime gifting may not be so unwelcome. Many of the thresholds in the exemptions noted above have stayed frozen for years, and thereby are not reflective of current society’s behaviours and attitudes towards gifting. There are also many different exemptions, and it can often be confusing to work out which exemption is best used for which event, with one of the pitfalls noted above being a lack of understanding of how the different exemptions interact. Some of the previous recommendations of HM Treasury’s now closed Office of Tax Simplification, in order to reform lifetime gifting, was for the 7 year period to be reduced to 5 years, replacing some of the exemptions (for example the annual exemption and gifts in consideration of marriage or civil partnership) with one overall personal gifts allowance.
These simple changes would go some way to clarifying the often confusing lifetime gifting landscape. We will need to watch this space as to whether more drastic changes are afoot for lifetime gifting and Inheritance Tax come the next Budget in October. However, in the meantime, if you are considering making a lifetime gift, it is important to review the Inheritance Tax implications before embarking on any gifting, both to consider if you can make use of the many available exemptions and allowances, as well as to avoid any potential Inheritance Tax pitfalls.
Lifetime gifting can be very rewarding, allowing you to see the impact of your gift whilst you are still alive. If you would like to better understand how lifetime gifting could affect your financial arrangements, please get in touch.