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With a growing number of estates becoming liable for inheritance tax, one of the most effective ways to reduce a future bill is by giving money away during your lifetime.
But this strategy only works if you follow the rules and keep accurate records of your gifting. In this guide, we explain what to document and how to stay within HMRC guidelines.
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There are several different gifting allowances you can use to minimise the impact of inheritance tax (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.
Gifts above this value to individuals – known as “potentially exempt transfers” – are only exempt from IHT if you live for seven years after making the gift. Gifts that are greater than the £325,000 allowance (the nil-rate band) may get taper relief if the person dies within seven years of giving away the money.
This means that if you die between three and seven years after making the gift, any inheritance tax due on the portion of the gift that is over £325,000 is reduced on a sliding scale. In addition, you can gift up to £250 per person each tax year, provided no other exemption is used for the same person.
There are also 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 £1,000 without worrying about IHT.
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, explains that the gift must be out of income, not capital. Income could come from salary, pension, interest, dividends or rental income, for example. “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,” he adds.
Birthday and Christmas gifts from regular income are also exempt from inheritance tax, 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 – will be responsible for reporting these gifts through the IHT400 form, particularly those made in the seven years prior to death.
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: “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. 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.
“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,” she adds.
Again, keep a clear record of all these gifts, store it with your will and tell your executors where to find it.
When someone dies, their estate is reviewed and a value is calculated for inheritance tax purposes. If IHT is likely to apply, the executor will need to complete form IHT400 (along with several separate forms) to report and pay the IHT 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 gifts over the nil-rate band (£325,000 per person), your executor will also need to complete form IHT403, reporting the value of all gifts made within the seven years before death.
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.
We partner with Co-op Legal Services to offer advice and services for you and your family.
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