- Financial planning
- 4 minute read
It’s important to take the time to consider the later years of your life, especially when it comes to how your assets will be distributed when you pass away. But if you’re thinking of gifting your dependants or members of your family an early inheritance, there is some further planning required and an understanding of the inheritance tax rules needed, so that you can ensure your wealth is fairly passed on to your giftees.
In this scenario, consulting a financial adviser can help you to avoid unforeseen tax liabilities. In this article, we’ll explain further about Inheritance Tax and guide you through what you need to know if you’re thinking of gifting your inheritance early.
How does Inheritance Tax work?
Inheritance Tax (IHT), in its simplest form, is the tax charged on the estate of someone who has passed away. The value of the estate in question is the sum of your assets, such as savings, investments, and property.
For some, IHT isn’t something to consider, as the current allowance for any individual in the UK is £325,000. This amount is known as the nil-rate band (NRB). If your assets fall below this threshold, then there is nothing to pay. However, if the total of your estate is valued as higher than the NRB, the executor of your will or the administrator of your estate will need to facilitate the payment of 40% to HMRC — the standard IHT rate. This 40% rate is applied to any estate worth more than the £325,000 NRB.
There is some relief available if you decide to pass your family home on to your children or grandchildren. This relief equates to an extra £175,000 on top of the standard IHT allowance. Taking this into account, your allowance can be extended to £500,000 when including this type of property inheritance, or if you’re part of a couple, your combined assets can equate to £1,000,000 before being subject to IHT.
Things to consider before gifting inheritance early
It doesn’t have to be the case that you need to wait until you’re gone to give your money to your chosen giftees, and this is in fact one of the simplest ways to reduce your estate before the time of your death. By gifting your inheritance early, your assets may then fall below the taxable threshold.
Planning for this will always depend on your personal situation, however a good place to start is consolidating and calculating the total value of your estate, so you have a rough idea of how much it would be worth if you were to pass away. If your estate exceeds the IHT allowance, then you can begin planning or consulting a financial adviser to make a plan, which could involve gifting your inheritance early.
There are certain aspects to think about when gifting money early:
- The small gift amount - The current limit for a cash gift to a single recipient is £250 a year, which can be distributed to as many people as you like (as long as they are not already a gift recipient), and is unaffected by tax implications.
- Annual gift amount - For any amount above £250, the next level is a total of £3,000, which is an annual exemption from IHT, and can be gifted to someone within a tax year. Something to always remember, is that if you do not use the annual exemption amount in the previous tax year, you can carry it forward to the next and gift up to £6,000 to your nominated person. This can only be carried over for one tax year.
What is the seven-year rule?
If you’ve decided to gift your inheritance early and it is above the level of the annual exemption of £3,000, then you should become familiar with the seven-year rule that applies to these types of gifts, known as Potentially Exempt Transfers. This gift can be of any value, and is exempt from IHT, if you live longer than the seven years after the time you gave the gift.
If you unfortunately pass away within this time, then the money gifted will be classed as a taxable asset. The time period is a factor for the rate of charge and is calculated as followed, before the time of death:
- Less than three years: 40%
- Three to four years: 32%
- Four to five years: 24%
- Five to six years: 16%
- Six to seven years: 8%
- More than seven years: 0%
It is worth noting that no tax will be due on the gift if it falls within the £325,000 nil-rate band (NRB), however the full value of the gift will reduce the available NRB at any time within 7 years.
What are the exceptions to the rules?
Alongside the annual allowance, which is not subject to IHT, there are some further exemptions from tax liabilities, which enable you to gift some of your inheritance early.
- Gift to a spouse – Regardless of timing, if you leave all of your assets to a spouse (from marriage or a civil partnership) then no IHT will need to be paid. This also applies to an unlimited number of gifts paid between you, as long as they permanently live in the UK.
- Wedding gifts – If your child is getting married, you can gift them up to £5,000 tax-free. For a grandchild, you may gift a total of £2,500 and for a non-immediate family member, you can give up to £1,000 – again, all exempt from IHT.
- Surplus income – A tax-free gift can come from your extra income, if contributed to a giftee on a regular basis, and goes towards their living costs for example. This can also be gifted into their savings account or their life insurance policy. However, a detailed record needs to be kept of these continuous payments to ensure it is clear they are not a liable asset.
The benefits of giving your giftees an early inheritance
Although it may seem like the distant future, there is never a better time than now to think ahead and take Inheritance Tax into consideration for your financial planning. If you are in a position to gift an early inheritance through the allowances and exceptions mentioned above, you may potentially minimise the future tax liabilities incurred for your giftees in the future.
To find out more about Inheritance Tax planning or if you have any questions about financial advice, contact us to find out how we can help.
Please note that any tax benefits will depend on your personal tax position and rules are subject to change. The value of investments can go down as well as up, and you may get back less than you invested.