How to avoid inheritance tax by giving your money away

While the rumoured cut in inheritance tax failed to materialise in the Autumn Statement, there are ways to beat the tax by passing money to your family while you’re still alive. We explain how the gifting rules work.

Boxed present wrapped with cash
(Image credit: redmal)

Many families worry about inheritance tax and how they can minimise how much of their estate goes to the taxman. One way to reduce HMRC’s share and significantly improve the finances of the younger generation is to give away money while you are still alive.

There was speculation that the chancellor would use his Autumn Statement last month to cut the 40% IHT rate, or raise the £325,000 tax-free allowance (also known as the nil-rate band). However, an announcement on the much-hated tax failed to appear - although we could still see something in next year’s Budget ahead of the General Election.

For now, the IHT rate and allowances remain the same. But there are ways to beat the tax and be a “Scrooge” to HMRC this Christmas. In fact, you can solve two problems - what to buy young relatives for Christmas, and how to avoid an IHT bill - by gifting your cash. Giving money as a present can also improve a loved one’s financial wellbeing and enjoyment.

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More and more grandparents are doing just this, according to a report by M&G Wealth. The number of youngsters that have received financial gifts from their grandparents has jumped from 48% last year to 64% this year. Popular reasons include money for savings and investments, a house deposit, travelling and help with bills.

Kirsty Anderson, savings and pensions specialist at M&G Wealth, tells MoneyWeek: “Whilst grandparents don’t want to give up all control of their money, if they are financially able to help grandchildren now, and see the benefit, not only does it help the grandchild but it helps to reduce any possible IHT liability on their estate.”

IHT receipts continue to soar: the government raked in £4.6 billion between April and October, a rise of £500 million from the same period a year earlier.

So, if you want to avoid paying the tax and start passing on inheritance money while you're still alive what’s the best way to do it? Before you start splashing the cash think about how much you will need. Only give away what you can afford to lose; don’t risk your retirement or money to cover future care costs

Anything you give away will not count towards a future inheritance tax bill, provided you live for seven years after the gift. 

But there are also gifts that become immediately free of IHT, you just need to know the limits and rules around this.

Here’s our guide to the gifting rules.

The tax rules for financial gifts 

The first thing to note is that gifts of any value between UK-domiciled spouses and civil partners are free from inheritance tax. 

Lesley Mackintosh, founder of Independent Women, a community of financial advisers, adds that the same is true for gifts to charity, as they are always inheritance tax-free. “Particularly at this time of year when many are in need, your gift can make a significant difference in others’ lives while also reducing your potential inheritance tax bill,” she comments. 

In terms of giving to other people, such as children, grandchildren, friends or other relatives, monetary presents can be free from tax as long as they meet the following conditions: 

  • Total gifts made by you in a tax year are less than £3,000 – or £6,000 for a couple. You can also carry forward any unused £3,000 allowance from the previous tax year, making financial gifts of up to £6,000 possible this Christmas – or £12,000 for a couple.  
  • Small gifts of up to £250 can be made to any number of people in the tax year, provided the total to any one person does not exceed £250. If it does, this exemption does not apply and all gifts would start to use up the aforementioned £3,000 allowance.
  • Gifts out of regular income that are part of normal ongoing expenditure can also be made. These gifts must be “regular” in nature, made from income rather than capital, and cannot affect the donor’s standard of living.
  • Money can also be given as a gift tax-free to celebrate a marriage or civil partnership, of up to £5,000 from each parent, £2,500 from each grandparent and up to £1,000 from any other person. These do not use up any of the other allowances.

Ian Dyall, head of estate planning at wealth management firm Evelyn Partners, comments: “These exempt gifts reduce the size of the gifter’s estate immediately. A growing number of estates are finding themselves just the wrong side of the nil-rate band of £325,000, which has been frozen for 14 years, so even modest lifetime gifts could come in useful as a way of saving executors and beneficiaries the rigmarole and expense of settling IHT before probate.”

Mackintosh adds that keeping a record of any cash gifts is important as it will help your executors in the future and assist your estate passing through probate as quickly as possible to the people you intend it.

Other tips for gifting money 

If you intend to give money that exceeds the above gifting rules - for example, £10,000 from your savings as a Christmas present for a granddaughter to help her buy a property - then the seven-year rule applies. 

This means the gifts are referred to as “potentially exempt transfers”. If you die within seven years, the nil-rate band is reduced by the value of the gifts (so in a sense they are counted as never having left the estate), and tax on assets above the threshold will be due at up to 40%.  

Dyall explains: “We say ‘up to’ because if the gifts put together exceeded the nil-rate band then taper relief can apply, which reduces the tax paid on older gifts. If there were three to four years between the date of gift and death, the IHT rate lowers to 32%, while at six to seven years the rate falls to just 8%. All of which means that large gifts exceeding the nil-rate band can reduce an IHT liability even if they fall foul of the seven-year rule.”

Think about where the money is going that you are gifting. Is it going to sit in your loved one’s savings account? In which case, beware of the recipient having to pay income tax on their interest, if it breaches their personal savings allowance. 

Mackintosh comments: “To avoid an income tax liability on the cash gift you are making, consider other savings products such as an ISA (cash or stocks and shares), junior ISA, or potentially even a pension. All of these provide a tax-free environment in which your gift can grow and compound, and in the case of a pension, is immediately increased by 20%, 40% or 45%, depending on your loved one’s tax rate.” 

Ruth Emery
Contributing editor

Ruth is an award-winning financial journalist with more than 15 years' experience of working on national newspapers, websites and specialist magazines.

She is passionate about helping people feel more confident about their finances. She was previously editor of Times Money Mentor, and prior to that was deputy Money editor at The Sunday Times. 

A multi-award winning journalist, Ruth started her career on a pensions magazine at the FT Group, and has also worked at Money Observer and Money Advice Service. 

Outside of work, she is a mum to two young children, while also serving as a magistrate and an NHS volunteer.