How gifting money this Christmas could lower your inheritance tax bill

Giving a loved one cash for Christmas isn’t the most imaginative present idea, but it can be ideal if you’re low on ideas and strapped for time. It could also reduce your inheritance tax bill.

Inheritance tax receipts surged to £5.8 billion in the first eight months of the current tax year, the latest figures from HMRC show, up £84 million annually and continuing an upward trend.

However, gifting money to friends and family this festive period could be a win–win – topping up their bank account and reducing the value of your estate for inheritance tax purposes.

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Reducing the value of your estate could see less of it exposed to a standard 40% tax rate (on any amount over the £325,000 nil-rate band).

Bear in mind, it's also worth keeping records of any gifts you have given so it is easier for the executor of your will to declare them to HMRC after you die.

Sarah Coles, head of personal finance at Hargreaves Lansdown, shared five ways you can use inheritance tax gifting rules this festive period to lower the value of your estate.

Max out the annual gift allowance

You can give money away up to the value of £3,000 each tax year without it falling into your estate through the annual gift allowance.

The allowance can be split between multiple people so you could, for example, give £1,500 to one relative and £1,500 to another and would be within the allowance.

The annual allowance can also be carried forward to the next year.

“If you didn’t use any of your £3,000 allowance in the previous tax year, you can carry it forward and give £6,000,” Coles said.

Use the small gift allowance

You can also give as many gifts of up to £250 per person each tax year, so long as you haven’t given that same person money through the annual exemption.

This is known as the small gift allowance.

Give gifts for a wedding

You can give larger financial sums within inheritance tax rules if it’s a gift for a wedding or a civil partnership.

Coles said: “You can give £5,000 to a child as a wedding present, £2,500 to a grandchild or great-grandchild and £1,000 to any other person.”

Wedding gift allowances can be combined with other allowances as well, except the small gift allowance.

Gifting money out of your “surplus income”

You can gift money if it’s part of your “surplus income” through what’s known as the “normal expenditure out of income” exemption.

This allows you to gift potentially more than £3,000 per year (the current annual gift allowance) without it being subject to inheritance tax later on.

You have to meet three conditions to qualify for the exemption. These are:

• The gifts must be part of normal expenditure (you need to establish a clear, regular pattern of gifts. Christmas can be a good time to offer these gifts once per year)
• You have to be able to maintain a normal standard of living after making the gift (and avoid dipping into savings or investments to pay for it)
• The gift has to come from “normal” income. This includes pension, rental and dividend income.

Coles said: “You don’t need to make the gift direct to the individual. You can pay into a Junior ISA for children, which they can access when they turn 18.”

It could be worth speaking to a tax expert or financial adviser if you’re considering this exemption as the rules can be technical and complicated.

Potentially exempt transfers (PETs)

You can gift larger sums of cash that’s exempt from inheritance tax through the “seven year rule”. Gifts given within this seven-year period are known as Potentially Exempt Transfers (PETs).

Coles said: “You might choose Christmas as a time to make these gifts. It’s not just a very generous Christmas gift, it’s also a useful time when the family is together, to discuss any issues that come up around the topic.”

The rules dictate that gifts are not subject to inheritance tax, as long as you don’t die within seven years of issuing them.

If you do die within seven years, the inheritance tax due is paid on a sliding scale known as “taper relief”. Tax is paid on the estate at different rates depending on when you died.

For example, gifts given in the three years before your death are taxed at 40%, while gifts given three to seven years before your death are taxed between 32% and 0%.

We explain what a trust is in another article – and how they can be used to pay less inheritance tax.