Navigating the complexities of inheritance

As we age or accumulate more wealth, protecting and preserving our assets for future generations can become increasingly important; Inheritance Tax (IHT) planning, estate planning, or intergenerational wealth planning, involves strategically managing your estate to minimise tax liabilities and ensure your wealth is passed down to your loved ones in the most tax-efficient manner possible.

Effective planning can significantly impact the financial wellbeing of your heirs, should one of your objectives be to provide for someone upon your death, considering the various strategies and tools available for safeguarding your estate will form an essential part of your financial plan.

A common question we receive from clients is whether to gift assets during their lifetime or wait until they have passed away. The answer depends on your personal and financial circumstances alongside your objectives.

Gifting can provide immediate support to family members and potentially reduce the size of your estate, lowering the IHT burden, but careful consideration must be given to the gifts' timing, amount, and recipients to ensure that they align with your long-term goals, comply with tax regulations, and that the money is used by the recipient as you intend. Understanding these nuances is key to making informed decisions that will benefit you and your beneficiaries.

Understanding Inheritance Tax

When you pass away IHT is potentially payable to HM Revenue & Customs (HMRC). The amount due depends on your estate's value minus any debts and after all available thresholds have been used. These thresholds are the nil rate band (NRB) and the residence nil rate band (RNRB). At a high level, the NRB is £325,000, and the RNRB is £175,000, the latter of which is only available if you leave your home to direct descendant(s) and is reduced by £1 for every £2 an individual’s chargeable estate upon death exceeds £2 million. The standard rate of IHT due to HMRC on amounts over these thresholds is 40%. In some circumstances, exemptions and reliefs may be available which reduce the IHT liability.

Why do we gift?

We gift for two common reasons: We want to help our family and loved ones now, when they need it, and whilst we can see them enjoy it, as opposed to when we have passed away. This is often called a ‘living inheritance’. Additionally, we may have a large estate and wish to reduce its value so that our beneficiaries pay less or no IHT when we pass away.

How much can you gift?

In short, you can gift how much you want to whoever you like and whenever you like. If these gifts fall within the ‘annual gift allowances’ or are made from your regular surplus income, they automatically fall outside your estate for IHT tax purposes. Otherwise, you must survive seven years after making the gift before the gift is excluded from IHT tax calculations.

The impact of sequencing gifts

The sequencing of gifts can impact the wealth you want to pass on. In addition to the seven-year rule, there is the less well-known fourteen-year rule. Giving a gift outright to an individual and/or Absolute/Bare Trust in excess of the annual allowances is known as making a ‘Potentially Exempt Transfer’ or a PET.

Potentially Exempt Transfers and Their Uses

For example, a common reason for making a PET might be to help a child onto the property ladder. For the gift to fall outside of your estate for IHT tax purposes, you need to survive seven years from when the gift is made. If the PETs made in the seven years before the date of death exceed the NRB (£325,000), there is gradual tapering on the tax rate once you have survived for over three years. The longer you survive after making the gift (between three and seven years), the greater the tapering.

Chargeable Lifetime Transfers

Should you settle any money into a relevant property trust, such as a Discretionary Trust, these gifts are known as ‘Chargeable Lifetime Transfers’ or CLTs. An example of such a settlement might be grandparents wanting to pass money down to their grandchildren. A common reason for this may be that their children already have a large estate, so if they were to inherit any more, it would be unhelpful for their own IHT position, alternatively the settlor (the person making the gift into Trust) might wish to retain control over how the money is used.

Complications in the gift order

Complications may arise when an individual has passed away and has made both PETs and CLTs. This is because the order of these gifts can result in bringing fourteen years’ worth of gifts into the IHT calculation. When considering which gifts are liable to IHT, the gifts are placed in the order they were made, starting with the oldest and moving towards the date of death.

HMRC rules on failed PETs

HMRC rules are such that any CLTs made in the seven years before any ‘failed PETs’ must also be brought into account. If an individual makes a PET and dies within six years and eleven months, the PET fails. From the ‘failed PET’ date, HMRC will look back a further seven years and include any CLTs in their calculation to determine the IHT due on the PET.

Annual Gifting Allowances

Under current legislation, everyone can gift away £3,000 per year. This is called your ‘annual exemption’. Any unused allowance can be carried forward to the following tax year; however, it cannot be carried over again. There is also a wedding allowance of varying amounts depending on the relation, which must be made before the wedding, and the wedding must happen: £5,000 to a child, £2,500 to a grandchild, £1,000 to a relative or friend. Wedding gifts can be combined in the same year with the annual exemption.

Small Gifts Allowance

You can also make gifts of up to £250 to as many different people as you like, as long as the person has not received more than £250 from you that tax year and you have not used another allowance on that person. 

THIS ARTICLE DOES NOT CONSTITUTE TAX, LEGAL, OR FINANCIAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH. TAX TREATMENT DEPENDS ON THE INDIVIDUAL CIRCUMSTANCES OF EACH CLIENT AND MAY BE SUBJECT TO CHANGE IN THE FUTURE. FOR GUIDANCE, SEEK PROFESSIONAL ADVICE. THE FINANCIAL CONDUCT AUTHORITY DOESN'T REGULATE TRUST PLANNING AND MOST FORMS OF INHERITANCE TAX (IHT) PLANNING. SOME IHT PLANNING SOLUTIONS PUT YOUR MONEY AT RISK, AND YOU MAY GET BACK LESS THAN YOU INVESTED. IHT THRESHOLDS DEPEND ON INDIVIDUAL CIRCUMSTANCES AND THE LAW. TAX AND IHT RULES MAY CHANGE IN THE FUTURE.