By making a tax-free gift now, you might be able to make things more efficient from an inheritance tax perspective when you die.
But doing this is not always straightforward. Whether your gift is tax-free depends on factors such as the recipient’s relationship to you, the value of the gift, and the all-important “7-year rule”.
What is the 7-year rule?
If you pass away within seven years of making a gift and Inheritance Tax is applicable, the amount of tax due after your death depends on when the gift was given.
Gifts given within three years before your death are taxed at a rate of 40 per cent, while gifts given between three and seven years before your death are taxed on a sliding scale called “taper relief”.
What counts as a gift?
Various assets can be considered as gifts, including money, household and personal goods like furniture, jewellery, and antiques, as well as houses, land, and buildings.
Stocks and shares listed on the London Stock Exchange, as well as unlisted shares held for less than two years before your death, are also regarded as gifts.
If you sell something for less than its market value, the difference in value can also be seen as a gift. For example, if you sell your house to your child below its market value, the gap between the actual value and the sale price counts as a gift.
However, anything specified in your will does not count as a gift but is instead considered part of your estate. Your estate encompasses all your money, property, and possessions that are left behind after your death. The value of your estate is used to determine whether inheritance tax needs to be paid.
Are there ways to give gifts tax-free?
Certain individuals are exempt from paying inheritance tax on gifts. Spouses or civil partners, for instance, are not subject to this tax on gifts exchanged between them, regardless of the amount. As long as they permanently reside in the UK and are legally married or in a civil partnership, they can give each other unlimited gifts during their lifetimes.
Gifts made to charities or political parties are also exempt from inheritance tax.
You can also utilise various allowances provided each tax year to give away money tax free.
The annual exemption allows you to give away up to £3,000 worth of gifts each tax year without them being included in the value of your estate.
This allowance can be gifted to a single person or divided among multiple individuals. If you don’t maximise the exemption one year, the unused portion can be carried forward to the following tax year, but only for one year.
There is also a small gift allowance, which lets you give as many gifts of up to £250 per person as you wish during a tax year, provided you have not already made use of another allowance for the same person.
Gifts given for birthdays or Christmas from your regular income are exempt from inheritance tax, as are wedding gifts – though these are subject to limits depending on who is getting married. Within each tax year, you can give tax-free gifts of up to £5,000 to your child, £2,500 to a grandchild or great-grandchild, and £1,000 to any other person. If you’re giving gifts to the same person, you can combine the wedding gift allowance with any other allowance except the small gift allowance.
What is the inheritance tax threshold?
The tax-free basic threshold for inheritance tax, known as the nil rate band, is currently set at £325,000. Your estate won’t pay any tax on this amount when you die. Anything above this is usually taxed at 40 per cent.
But there are several situations in which the estate would be taxed differently. For example, if you leave everything about the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club, then there is normally no tax to pay.
Additionally, if you are leaving your home to your children, the threshold increases to £500,000.
You can also secure a reduced rate of 36 per cent on some assets if you leave 10 per cent or more of the net value of your estate to charity.
