Eight tax-efficient ways to make a gift

GiftFind out the most tax-safe ways to make gifts in order to reduce your inheritance tax (IHT) burden.

In 2007 George Osborne, then shadow Chancellor, promised to set the inheritance tax threshold at £1 million. More recently, modest increases had been proposed from 2015 onwards. Now, however, it seems likely that the IHT nil-rate threshold will be frozen at £325,000 until 2019. 

Given this U-turn, what is certain in the immediate future is that an increasing number of families or individuals with significant wealth will have an exposure to IHT.

One of the simplest ways to reduce this IHT burden is by giving away assets in your lifetime, but care is needed to ensure that such gifts are effective for IHT purposes to prevent unexpected liabilities. We detail below some of the relevant considerations when using gifts to manage your IHT exposure.

1. Seven-year rule

No IHT is generally payable on gifts to individuals made in your lifetime providing you survive for seven years after making the gift. If you don’t survive the seven years, the gift falls back into your estate but with a reduction in the IHT payable if it has been over three years from making the gift.

In addition, the value which falls back into your estate is the value of the asset at the date of gift not its value at the date of your death so it is useful for assets expected to rise significantly in value. With any gift, however, beware of any assets you continue to benefit from (see point 8 below).

2. Exempt gifts

Certain gifts are exempt from IHT immediately and don’t require the seven-year rule to be effective.

  • Annual exemption – you can give away £3,000 a year with no IHT consequences. Any unused annual allowance can be carried forward and used in the following tax year.
  • Small gifts – exempt gifts up to the value of £250 can be made to any number of individuals in one year.
  • Wedding/civil ceremony gifts – these are exempt provided the gifts fall within the prescribed limits (parents – £5,000 each; grandparents – £2,500 each;  other – £1,000 each). The gift has to be made, or promised to be made, on or shortly before the wedding/civil ceremony.

3. Gifts for maintenance

A gift for family maintenance doesn’t give rise to an IHT charge. This covers gifts for the education of children or maintenance of a dependant relative.

4. Gifts out of income

Gifts made out of after-tax income are exempt from IHT. To qualify for the exemption the gifts must: form part of normal expenditure (ie, there is a pattern, or intended pattern to the gifts); be out of income (ie, not from existing capital); not impact on your standard of living.

There’s no cap on the amount that can be gifted under this exemption, provided that the above conditions are met, so this can be a valuable exemption. HM Revenue & Customs is strict in its interpretation of the conditions so do seek professional advice before relying on this exemption.

5. Exempt beneficiaries

Gifts can be given to exempt beneficiaries, which are therefore also exempt from IHT. Again, these gifts don’t require you to survive seven years and are effective immediately. The main types of exempt beneficiaries are: spouse/civil partner, provided they are domiciled in the UK; a 'qualifying' charity; and classes of gift which are broadly for the public good.

6. Transfer of assets into a trust

If assets are properly transferred into a trust, they shouldn’t form part of your estate, provided you can’t benefit from them. There is, however, an immediate 20% IHT charge on transfers into a trust in your lifetime, unless the value transferred is below your available IHT nil-rate threshold or IHT relief is available on the asset (for example, business assets discussed below).

7. Gift of business assets

A gift of business assets – such as an interest in a business or unquoted shares – could be exempt from IHT due to the availability of business property relief (BPR) at a maximum rate of 100%. As mentioned above, this can also avoid the 20% entry charge on a gift into trust. There are certain businesses which do not qualify – such as those making or holding investments – so always check with a professional adviser before relying on BPR.

Provided the donor survives seven years, or the recipient still holds the assets at the date of the donor's death (and they still qualify for BPR), IHT on death should be eliminated or minimised. If the assets are not gifted during your lifetime, BPR may still be available in your estate.

8. Gifts that you continue to benefit from

For a gift to be effective, you must not continue to benefit from the asset gifted. A common example is when the family home is gifted but you continue to live there rent-free. 

This is a 'gift with reservation' and the property will be part of your estate for IHT purposes, even if you survive seven years from making the gift. By paying a market rent for the property while continuing to live there you should, however, avoid a charge on death (subject to the seven-year rule above). The beneficiary will have to pay income tax on the rent they receive.

Keep records, seek advice

It is essential that records of gifts are kept to ensure that any IHT exemptions available are used and can be evidenced.

Finally, it’s also worth noting that, although IHT savings can be made by making gifts, there are often other issues to consider, for example, capital gains tax may be payable on the gift. It is always worth seeking professional advice before making substantial gifts.

Words: Emma Hunt, Tax Manager. Image: (cc) Asenat29/Flickr