The holiday season presents an opportunity for individuals to gift cash to loved ones, which not only spreads festive cheer but may also serve as a strategic financial move to reduce inheritance tax liabilities. Recent data from HM Revenue and Customs (HMRC) indicates that inheritance tax receipts reached an astonishing £5.8 billion in the first eight months of the current tax year, reflecting an increase of £84 million compared to the previous year. This trend highlights the growing financial burden of inheritance tax, which stands at a standard rate of 40% on estates exceeding the £325,000 nil-rate band.
Gifting money to family and friends could effectively lower the value of your estate, thereby minimizing potential tax exposure. It is essential to keep detailed records of such gifts to assist the executor of your will in reporting them to HMRC after your passing.
Maximizing Gift Allowances
Sarah Coles, head of personal finance at Hargreaves Lansdown, recommends several strategies to leverage inheritance tax gifting rules during this festive season. The first approach is to maximize the annual gift allowance, which permits individuals to give away up to £3,000 each tax year without those gifts being included in their estate. This allowance can be divided across multiple recipients. For instance, one could gift £1,500 to a relative and another £1,500 to a friend, all while remaining within the allowance. Importantly, any unused portion of this allowance can be carried forward to the next tax year.
Another beneficial option is the small gift allowance, which allows individuals to give gifts of up to £250 per recipient, provided that the same individual does not receive any funds under the annual exemption. This enables donors to gift to numerous people without affecting their inheritance tax liability.
Special Circumstances and Alternative Strategies
Gifts intended for weddings or civil partnerships also fall under favorable tax rules. Coles explains that individuals can gift up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to any other person. These wedding gift allowances can be combined with other exemptions, except for the small gift allowance.
Additionally, individuals may consider gifts from their “surplus income” under a provision known as the “normal expenditure out of income” exemption. This allows for larger gifts beyond the annual allowance if three criteria are met:
1. The gifts must form part of normal expenditure, established through a consistent pattern of gifting—Christmas can serve as an ideal time for such contributions.
2. The donor must maintain a standard of living that does not require them to dip into savings or investments to finance the gifts.
3. The gifts must originate from regular income sources, such as pensions, rental income, or dividends.
Coles notes that gifts need not be delivered directly to recipients; for example, contributions to a Junior ISA for children can be made, allowing access once they reach 18.
For those considering gifting larger amounts, the “seven-year rule” can be employed through Potentially Exempt Transfers (PETs). Gifts made within this timeframe are exempt from inheritance tax, as long as the donor does not pass away within seven years of the gift. If the donor dies within this period, the inheritance tax owed is calculated on a sliding scale known as “taper relief.” For example, gifts given within three years prior to death are taxed at 40%, while those given between three and seven years prior are taxed at rates ranging from 32% to 0%.
As the festive season approaches, individuals may find it advantageous to consult with a tax expert or financial adviser to navigate the complexities of these gifting rules effectively.
