Gifting has long been an effective way to manage Inheritance Tax (IHT) obligations and estate planning processes, but changing rules mean that it’s more important than ever to understand what you can and can’t gift to loved ones.
In the Autumn Budget last year, Chancellor Rachel Reeves opted to keep IHT thresholds in place until 2030. However, she also altered the Inheritance Tax rules surrounding pensions. As a result, from April 2027, unused pensions will no longer be exempt from IHT, meaning that tax may have to be paid on your pension when you die.
For many households, these rule changes won’t have a major impact. With the IHT threshold set at £325,000 (and higher again if the deceased is passing their home to their child) until at least April 2028, tax will only be paid on estates once they exceed this limit. However, with the upcoming change to include unused pensions, more UK households are in danger of being hit by tax bills when it comes to estate planning.
Although future decisions on IHT rule changes are yet to be determined, speculation is once again mounting that the Chancellor may be considering extending the seven-year rule to 10 years or abolishing it altogether in favour of a lifetime gift allowance.
The seven-year rule stipulates that you can gift your wealth to loved ones on a tax-free basis, provided that the gifting occurs more than seven years before you die.
Any changes could make it more likely for your estate to become liable for Inheritance Tax later down the line.
With this in mind, it’s worth adapting your gifting strategies to take any possible taxation changes into account.
Gifting to Reduce Your Estate
While you’re free to gift as much money as you want to your loved ones, there are a few measures you must take to ensure that it remains tax-free.
Because of the seven-year rule that’s in place today, you can give what you want without your children or family paying IHT just so long as you live for more than seven years after you make the gift. However, if the beneficiaries make gains from the gift, they could be liable to pay capital gains tax (CGT), for instance.
If you don’t live for more than seven years after you’ve made the gift and your estate is over the IHT threshold, your loved ones may have to pay Inheritance Tax.
The seven-year rule works in a tapered fashion, and if you die within three years of giving a gift, the beneficiaries may have to pay 40% in IHT. If the gift was given three to four years before death, the tax rate is reduced to 32%, then 24% for four to five years before death, then 16% for five to six years, and 8% for six to seven years.
This means that if you’re thinking of gifting money or assets to loved ones, it pays to make a record of what you gave, who you gave it to, when it was gifted, and how much it’s worth at the time of gifting. These insights can make it much easier for the executor of your estate to work out should they become liable for taxation.
Getting Started Early
With so much uncertainty surrounding the future of Inheritance Tax, it’s certainly worth thinking about gifting your estate as soon as possible, particularly if you believe that it will exceed the £325,000 threshold and be liable for IHT.
Fortunately, there are plenty of ways to get in early with gifting, and when gifting to your children, using ISAs in your inheritance planning can be an excellent consideration.
Because ISAs can be left to spouses or civil partners on a tax-free basis, they can help you to manage your estate more effectively. Junior ISAs can also be used for gifting purposes in a more tax-efficient manner.
Not only do Junior ISAs carry a £9,000 annual tax-free allowance for account holders under 18 years of age, but it’s also possible for parents, grandparents, and even family friends to make deposits on behalf of their loved ones if the Junior ISA provider facilitates this. This means that as a grandparent, you could help towards the parents’ regular contributions by gifting money earlier and in a more effective way than waiting until later in life (subject to the annual gift-giving allowances).
Charitable Donations
Donations or gifts to charity aren’t subject to IHT, and this can help you to manage your estate in an effective manner to keep your beneficiaries from paying significant sums in tax.
Notably, any charitable donation that’s equivalent to at least 10% of your estate actively lowers any Inheritance Tax payable elsewhere to 36%, making the donating of your funds an effective strategy in estate planning if you’re set to transfer a significant amount of wealth in the future.
Prepare to Adapt Your Plans
Inheritance Tax rules are always subject to change, so if you’re planning your estate, it’s best to make sure that your strategy is adaptable enough to cope with changes to the seven-year rule or other future budget alterations.
When caring for the future of your loved ones, the last thing that you want is for the money you leave them to fall into the hands of the taxman. But by keeping up to date with changing rules and by gifting in a timely manner, you can help to set those closest to you up with a windfall that can transform their lives.
