As property values and asset wealth continue to rise across the UK, more families are finding themselves exposed to Inheritance Tax. Lifetime gifting can be an effective way to reduce the value of an estate and pass wealth to loved ones more tax efficiently, but careful planning is essential to ensure gifts qualify for available exemptions.
In the tax year 2009-2010, the nil rate band was set at £325,000. This meant that everyone could leave at least £325,000 in their will before any Inheritance Tax became payable. This rate has been frozen since, while property prices and inflation have continued to rise.
This means that, even with the introduction of the Residence Nil Rate Band in 2017 allowing for a potential extra £175,000 of tax-free allowance, an increasing number of estates are falling into the Inheritance Tax bracket.
Why estate planning matters
Estate planning can help to mitigate an Inheritance Tax bill, such as leaving mirror wills where a full estate passes to the surviving spouse and then to children on the second death which maximises the combined nil rate band allowances of £1 million.
However, it is often the case that this does not offer the maximum efficiency when it comes to the tax payable.
In this article, we will explore ways in which assets can be dealt with to minimise any future Inheritance Tax burden and the benefits and drawbacks of each.
Annual gifting exemptions
While the Nil Rate Band is set at £325,000, you can make small annual gifts which mean the nil rate band remains unused.
There are a few gifting thresholds you should be aware of.
The first is the annual allowance of £3,000. This means you can gift up to £3,000 per year and any unused allowance from the previous tax year. You can only claim allowances from the previous year if you have used up the full £3,000 allowance for the current year.
You can also gift small amounts for birthdays and weddings.
Gifting out of excess income
One of the most underutilised yet powerful exemptions is gifting out of excess income.
This allows you to make regular gifts that are immediately outside your estate, provided certain conditions are met. Notably, the gifts must be made from income, not capital, they must be received regularly and the gifting of the income must not affect your standard of living.
You should maintain a record of any gifts of this kind that are made, as documentation of this is essential when claiming the exemption.
Potentially exempt gifts and the 7-year rule
What if you have used up your annual allowance and you do not have excess income?
There is, of course, no rule to stop you from making gifts that could affect your Inheritance Tax position. Gifts of this kind are “potentially exempt gifts”.
Their exemption from Inheritance Tax is contingent on surviving 7-years from the date of the gift. This however would only be taxed at the full rate for the first 3-years. From the 4th year through to the 7th year, there is a taper relief rate.
Common mistakes in lifetime gifting
Even well-intentioned plans can fail if not structured correctly.
Common mistakes include:
- failing to document gifts, especially those from income
- continuing to benefit from gifted assets (known as “gift with reservation of benefit”)
- over-gifting and compromising personal financial independence
Careful planning and accurate record-keeping are essential to ensure gifts qualify for the intended exemptions.
Why early planning is important
By taking a proactive, lifetime approach and making full use of exemptions such as annual allowances, surplus income gifting, and the 7-year rule, private clients can protect their wealth and pass it on more efficiently.
The earlier planning begins, the greater the opportunity to make meaningful, tax-efficient decisions.
Ultimately, effective Inheritance Tax planning is not just about minimising tax, it is about ensuring your wealth benefits the people and causes that matter most to you.
Inheritance Tax Planning Guidance in Oldham
If you are considering lifetime gifting or would like advice on reducing a future Inheritance Tax liability, our Private Client team at O’Donnell Solicitors can provide tailored estate planning advice based on your personal and financial circumstances.
We advise individuals and families across the North West and wider UK on estate planning, wills and Inheritance Tax matters.
You can contact our team to arrange an initial consultation. Call 01457 761 320 or email enquire@odonnellsolicitors.co.uk.