Inheritance tax – Making gifts to reduce an estate’s value

Archived article

Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.

This article is an extract from Octopus Investments' publication "A guide to untangling inheritance tax" and it is reproduced with its permission. Read more about Octopus Investments

The article has been written in accordance with Octopus Investments’ understanding of the law and interpretation of it at the time of publication: remember tax rules can change and benefits depend on circumstances.

You can always simply ‘gift’ your assets away. However, there are some pitfalls to be wary of.

Some gifts are always inheritance tax free

For a start, any gifts between spouses or civil partners are free from inheritance tax. HMRC also gives you an annual gifting allowance of £3,000 every year. This is called the ‘annual exemption’. If you don’t use your full £3,000 annual exemption in one year, you can ‘carry over’ the remainder and use it the following year. However, you can only use this carry-over for one year.

You can also make small gifts (up to £250) to as many different people as you like, but you cannot use your annual exemption and your small gift exemption on the same person in the same year.

Wedding gifts are also free from inheritance tax, provided you keep to certain limits. You can make a wedding gift of up to £5,000 for your child, up to £2,500 for your grandchild, up to £2,500 as a gift to your spouse or civil-partner-to-be or up to £1,000 to anyone else. Of course, gifts between spouses are 100% exempt from inheritance tax.

Inheritance tax will not be paid on gifts made to charities, national museums, universities, the National Trust, political parties and some other institutions such as housing associations.

While other gifts may be subject to inheritance tax

These are usually called ‘potentially exempt transfers’. They typically become free from inheritance tax provided the person making the gift survives for seven years after the gift is made. If the person who made the gift dies within seven years, the value of the gift will be included in their estate. The person receiving the gift will have to pay any inheritance tax due.

It’s worth noting that the rate of inheritance tax due reduces if the person making the gift survives between three and seven years (known as ‘taper relief’). However, as the nil-rate band is applied against gifts made in the last seven years first, taper relief will only help where gifts worth more than £325,000 have been given away in the seven years before death.

Taper relief

Time between making gift and death Rate of taper relief
0-3 years No taper relief
3-4 years 20%
4-5 years 40%
5-6 years 60%
6-7 years 80%
Over 7 years No inheritance tax due

Keeping a record of gifts made during your lifetime

You’re not required to keep details of the gifts you make while you are alive, but it’s extremely helpful if you do. After you pass away, the executors who deal with your estate will have to account for any gifts you made during the last fourteen years of your lifetime. Keeping records will make this process much quicker.

Equity release schemes

In recent years, people have found most of the value of their estate tied up in their home and have turned to ‘equity release’ schemes as a way to unlock their capital. These schemes usually involve selling a percentage of the property and continuing to live there, or taking out a mortgage for the rest of your life. Both of these schemes directly reduce the value of your estate, as the money is repaid from the value of your home after you die.

The money can then be used as an income during retirement perhaps, or it can be used to make gifts, which would reduce the value of the taxable estate (provided you survive any gifts by seven years). After you die, the loan and any interest on the loan will be repaid from the value of the property. As the value of the property is reduced, any potential inheritance tax

to be paid on the value of the estate will also be reduced, provided the proceeds have been spent. Equity release can work for some people, but it also carries considerable risks. Make sure you talk to your family and a financial adviser who specialises in equity release before making any commitment.

Key points

  1. As no one knows what the future might hold, or how much money you could need in the future, making gifts can be a drastic way of reducing inheritance tax liabilities. Anyone making gifts loses ownership and control of their wealth as soon as the gift is made.
  2. Seven years can be a long time to wait for inheritance tax exemption, especially if you are elderly or in poor health.
  3. It’s worth keeping records of any gifts you make during your lifetime in order to make life easier for whoever has to deal with your estate.

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Important: This article is intended solely to provide basic information – neither Octopus Investments nor Wealth Club offer tax advice. If you are unsure, please seek specialist advice. Investments that qualify for inheritance tax relief place your capital at risk, and the value of the investment can fall or rise..

Wealth Club aims to make it easier for experienced investors to find information on – and apply for – investments. You should base your investment decision on the offer documents and ensure you have read and fully understand them before investing. The information on this webpage is a marketing communication. It is not advice or a personal or research recommendation to buy any of the investments mentioned, nor does it include any opinion as to the present or future value or price of these investments. It does not satisfy legal requirements promoting investment research independence and is thus not subject to prohibitions on dealing ahead of its dissemination. 

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