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This article is for general guidance only and is not financial or professional advice. It contains promotional content and links to financial products. All figures and information in this article are correct at the time of publishing. Laws, entitlements, tax treatments and allowances may change in the future. Before you make any decisions, you should get independent professional advice.
Inheritance tax (IHT) can be a complicated area when organising your personal finances. But with frozen allowances in this sphere and new rules from 2027 that will bring unused pensions into consideration, it’s a subject that will concern families increasingly over time.
One way to reduce IHT liabilities is to make financial gifts during your lifetime. But this only works if you stay within the tax rules, which can be helped by keeping accurate records. Here’s how best to plan your affairs.
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There are several different gifting allowances you can use to minimise the impact of IHT on your loved ones. Currently, you can give away up to £3,000 each tax year, without it being added to your estate for IHT purposes.
This is called your annual exemption, explains Steve Hughes, director and chartered financial planner at Five Wealth. “You can also carry forward any unused allowance from the previous tax year, making it £6,000 if you didn’t use it last year,” he says.
You can also give gifts of up to £250 to as many people as you like each tax year, provided you haven’t used another IHT exemption for the same person.
In addition, there are specific allowances for wedding gifts. Parents can give up to £5,000 to each of their children, grandparents can gift up to £2,500, and anyone else can give up to £1,000.
Gifts to individuals above these exemption limits – known as ‘potentially exempt transfers’ – are only exempt from IHT if you survive for seven years after making the gift. If these gifts exceed the nil-rate band of £325,000, so-called ‘taper relief’ may reduce the IHT payable if you die between three and seven years after giving away the money.
The reduction only applies to the tax due on the portion above the nil-rate band and not to the value of the gift itself.
As well as these gifting allowances, it’s possible to give away larger amounts on a regular basis by taking advantage of the making gifts out of surplus income rule. But to be exempt from IHT, these gifts must meet key criteria and be recorded accurately.
Ian Dyall, head of estate planning at Evelyn Partners, says that the gift must be out of income, not capital. Income could come from salary, pension, interest, dividends or rental income, for example.
He says: “It must also look regular in nature, so annually or on a more frequent basis, and similar in size rather than variable. And the gifts can’t affect your own standard of living.”
Birthday and Christmas gifts from regular income are also exempt from IHT, as are charity donations.
When making financial gifts, it’s essential to keep accurate records. Your executors – the people responsible for administering your estate after your death – may need to provide details of certain gifts made in the seven years prior to death using the IHT403 form, which sits alongside the main IHT400 return.
You can keep your records in whatever format you prefer, whether that’s a notebook, spreadsheet or digital file. Paislei Godley, director and tax specialist at Prime Accountants Group, advises on what to include: “Record who you made the gift to, your relationship with that person and the details around the gift: the amount, whether it was paid by bank transfer or cheque, and the date it was paid. It’s all about creating and maintaining a paper trail.”
It’s important to update your records every time you gift money to someone. Store your records safely and tell your executors where they are.
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It’s particularly crucial to understand and follow the guidelines for regular gifts from surplus income, as these can come under greater scrutiny from HMRC, the tax authority.
Donna Holmes, partner and head of personal planning at law firm Anthony Collins, says if you choose to gift out of normal income, it’s important to prove that you are not reducing your standard of living in order to increase your available disposable income for this purpose.
Keep detailed records to show that the gifts have been regular, whether that’s on a monthly, quarterly or annual basis, and include details of your usual expenses such as household bills, as well as details of your income.
It can be worth looking at HMRC’s IHT 403 form to understand the level of detail required, as your executors will need to fill in this form upon your death. “This will assist your executors in the smooth administration of your estate when the time comes,” adds Holmes.
If you want to gift a lump sum, be sure that the amount is affordable and that you have sufficient funds to provide for your future. This includes any care fees that might be required, says Holmes.
She adds: “You should also make sure you are happy to give away control and let the recipient do what they like with the money you give them. You don’t want to find yourself in a situation where you have given funds away and are short of what you need.”
“Or perhaps worse, you have given funds away and fall out with the recipient because they choose to use the money in a way you disagree with.”
Store clear records of these gifts with your will or other estate planning documents and tell your executors where to find them.
When someone dies, their estate is reviewed and a value is calculated for IHT purposes. If IHT is likely to apply, the executor will need to complete form IHT 400 (see above), along with several separate forms, to report and pay the tax due.
For smaller estates where no IHT is due, form IHT205 was previously used. But in most cases now in England and Wales where no IHT is due, the online probate process is used instead. In Scotland and Northern Ireland, forms may still apply.
If you’ve made lifetime gifts in the seven years before your death, your executor may also need to complete form IHT403, reporting the value of each gift. This form doesn’t need to include gifts made using the £3,000 annual exemption, or small gifts of £250 or less.
It can be wise to seek financial help when completing these forms. Godley says: “This is the point at which any records kept of gifting would be important, as they would provide proof of the timing and details of the gifts.”
The cost of administering the estate is paid from the estate itself, so good record keeping can make this process faster and more efficient.
Godley adds: “Without records, it would be a case of tracing back through bank statements to show gifting. This could potentially cause a problem for beneficiaries of your estate, as they may not be able to prove that gifts were exempt from inheritance tax.”
Keeping clear, accurate records makes life easier for your loved ones and ensures the gifts you give during your lifetime are passed on as intended – without unexpected tax consequences. Given the complexity of the rules and HMRC forms, you may want to seek professional advice first, whether you’re planning gifts or acting as an executor.
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