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This article is for general guidance only and is not financial or professional advice. Any links are for your own information, and do not constitute any form of recommendation by Saga. You should not solely rely on this information to make any decisions, and consider seeking independent professional advice. All figures and information in this article are correct at the time of publishing, but laws, entitlements, tax treatments and allowances may change in the future.
Giving away money or property during your lifetime can be a good way to reduce inheritance tax. By making gifts during your lifetime, it’s possible to get wealth out of your estate before you die, sparing your loved ones a 40% tax charge on your death.
But there’s a common tax trap that catches thousands of people every year. Here’s what you need to know to make sure your gifts don’t lead to an unexpected tax bill for your family.
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IHT planning is more complicated than it sounds, and families are being warned that some gifts are falling foul of HMRC rules.
According to figures obtained by TWM Solicitors, in 2023/24 HMRC conducted 220 investigations that resulted in gifts worth £61m becoming subject to IHT.
The reason? HMRC concluded that the gifts had not been wholly given away. They were what it calls ‘gifts with reservation of benefit’ – that means that the original owners continued to enjoy them in some way.
Gillian Dunlea, managing associate at TWM Solicitors, explains: “Many individuals give away assets to family during their lifetime to reduce the size of their estate, and therefore reduce the IHT bill when they die. However, if HMRC does not accept that an asset has been truly gifted, they will consider it part of the original estate, and it will be subject to IHT.”
Alan Barral, financial planner at Quilter Cheviot, describes gift with reservation of benefit rules as one of the biggest traps in IHT planning.
“The rules are deceptively simple on the surface but complex in practice. HMRC takes a strict view of what counts as a ‘gift’, and continuing to get any benefit from it will generally mean the gift hasn’t been effective for IHT purposes. Many people don’t realise that even seemingly minor benefits, such as using a holiday home for a few weeks a year or keeping the right to rental income, can keep the asset in their taxable estate.”
He adds: “Take the example of a parent who gifts their home to their adult child but continues to live there without paying a full market rent. To the parent, this may feel like a completed gift, but because they still live in the property, HMRC will treat it as though they never gave it away at all. The same principle could apply to other assets, such as gifting a classic car but continuing to drive it, the tax consequences can be both surprising and costly.”
Dyall says he’s encountered confusion amongst clients too, who are convinced the plans they’ve made are watertight. “I was presenting at a client event recently and a client was convinced he had mitigated his liability simply by putting his home in his child’s name. His child lived elsewhere and he was paying no rent. It was only when I showed him a similar example in the HMRC tax manual that he believed he had an issue. Resolving it is not easy, as transferring back to the father would result in a capital gains tax bill for the son.”
Ian Dyall, head of estate planning at wealth management firm Evelyn Partners, says that if you give away an asset but continue to benefit from it in some way, you’ll breach HMRC rules.
“If you gift an asset, it is usually treated as a ‘potentially exempt transfer’ (PET) and, provided you live for seven years after making the gift, it will no longer form part of your estate for inheritance tax.
“However, if you continue to use the asset, or the gift can be taken back if you choose to do so, then HMRC will deem there to be a reservation of benefit and the gift will continue to form part of your estate indefinitely.”
The only way that you can tax-effectively give away an asset but continue to benefit from it, is to pay for its use. If you do that, it must be the full market rate, not a nominal payment.
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The most obvious example where problems arise, is when people give the family home to their children and continue to live in it rent-free. But TWM Solicitors says these rules can catch out families in a number of other scenarios, including:
Ian Dyall points out that the rules can apply to trusts too. “We recently saw a trust created in 2000 which held assets worth £1m. The client thought that as the money was held in trust it would not be subject to inheritance tax. Unfortunately, he was named in the trust as a potential beneficiary of the money he settled in the trust. Therefore there was a reservation of benefit and all of the trust’s assets were part of his estate.”
With IHT currently charged at a rate of 40% on any assets in your estate that are above your tax-free threshold (£325,000 per individual, plus £175,000 if you are passing on a family home), it’s not surprising that families are exploring all opportunities to reduce the amount of IHT they pay.
But putting plans in place yourself could backfire, as Dyall points out. “Some people have tried to avoid the rule by selling their home, and giving the money to the children to buy a new home which the parents then live in. This potentially may avoid the reservation of benefit rules, as the parents never owned the new home, but if it does it is likely to be caught by another piece of anti-avoidance legislation called pre-owned asset tax.”
If you’re concerned about IHT, it’s best to seek legal advice or consult a financial planner that specialises in estate planning. They will be able to advise you on a raft of strategies that can be used to reduce an IHT bill.
That way you can be confident that, when the time comes, the plans you have put in place will stand up to scrutiny from HMRC and your loved ones won’t be hit with a surprise tax bill.
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