According to reports, Chancellor Rachel Reeves is once again targeting inheritance tax, with possible amendments to restrict the lifetime gifts that a loved one can give being considered for the Autumn Budget
Since chancellor Rachel Reeves is allegedly preparing a crackdown on the value of financial gifts people can make during their lifetime, inheritance tax regulations may become even stricter in the months to come.
According to The Guardian, there is a possibility of imposing a lifetime gifting cap to restrict the amount of wealth that can be transferred before death without incurring inheritance tax (IHT).
Another possible target is the seven-year rule, which is the taper rate of inheritance tax that applies to gifts made while you are still alive. Over time, this lowers the inheritance tax rate owed on the gift. An inheritance tax bill on the gift can be avoided by the family after seven years have passed since the gift was made.
"Reports that the Treasury is considering a lifetime cap on the value of gifts a person can make before death without incurring inheritance tax would represent a fundamental change to the way families pass on wealth," stated Rachael Griffin, a tax and financial planning specialist at wealth manager Quilter.
"Under such a cap, more gifts would be subject to IHT and could include both modest, regular family support and large transfers intended to lower inheritance tax rates.
According to a representative for HM Treasury, "We are concentrating on expanding the economy because it is the most effective way to improve public finances, as outlined in the Plan for Change. Our planning reforms, which are anticipated to increase economic growth by 6 points and reduce borrowing by 3 points, demonstrate that modifications to tax and spending policies are not the only means of achieving this.
"As part of our commitment to minimizing taxes for working people, we safeguarded working people's paystubs in the previous autumn's budget and upheld our pledge to not increase the basic, higher, or additional rates of VAT, employee national insurance, or income tax.
What are the rules regarding inheritance tax gifts?
Giving gifts to family members is a practical and efficient way to transfer wealth while also reducing the value of your estate for inheritance tax purposes, which will lower your IHT bill.
If a lifetime gift is within the annual allowance of £3,000 or the small gift allowance of £250 per year, it is immediately free from inheritance tax.
Greater disposable income allows people to give gifts, which are immediately free from IHT and have no upper limit. In the 2023 - 2024 tax year, the value of "gifts out of surplus income" increased by 177% to 144 million, from 52 million in the 2022 - 2023 tax year, according to TWM Solicitors' research.
Though they do have some restrictions, primarily a seven-year clock, larger lifetime gifts are also possible. Even if you give a gift of any size, it may be considered part of your estate for the purposes of calculating IHT if you die within seven years of giving it.
Since these large lifetime gifts are eligible for taper relief, the tax rate decreases with the passage of time. You will be required to pay the full 40 percent if they gave it to you within the last three years; if they gave it to you between six and seven years ago, the rate is lowered to 8 percent.
The tapering rules don't apply to the majority of gifts and are frequently misinterpreted. Only if you give gifts totaling more than £325,000 in the seven years prior to your passing are they significant.
The inheritance tax gifting regulations have been scrutinized before. A parliamentary all-party group proposed drastic changes five years ago, including imposing a flat tax rate on all lifetime gifts. However, their suggestions have since been abandoned.
"It is hardly surprising that inheritance tax is back in the frame, as it meets the government's criteria of raising tax without taxing people more during their working lives," stated Sarah Coles, head of personal finance at wealth firm Hargreaves Lansdown.
There is no assurance that there will be any changes at all because this is still merely being investigated. It means that people should think about their stance and avoid impulsive decisions they might later regret.
Using extra money to give gifts.
Nowadays, using extra money is one of the greatest ways to give gifts to loved ones while you are still alive. Giving away money without having to pay inheritance tax is permitted by the gifts out of surplus income rule.
It is not necessary for the donor to live for seven years following the gift in order for it to be exempt from IHT, unlike "normal" gifting. Because of this, giving gifts from extra money is especially beneficial for elderly or seriously ill individuals.
These gifts cannot be made from assets like savings or stock, but rather from surplus income, such as an unused salary, pension, or dividends, in order to be eligible. The annual gifting allowance of £3,000 for individuals is unaffected by surplus income gifts, which have no upper limit.
Importantly, the donor's standard of living cannot be lowered by these gifts; so, after making the gift, the donor cannot use their savings to pay for regular expenses.
According to solicitors at the law firm TWM, UK citizens are increasingly using surplus income gifting to lower their rising inheritance tax bills after inheritance tax reliefs were cut in the 2024 Autumn Budget.
"Families will soon have fewer ways to transfer wealth without being hit by IHT, so they're giving excess income to their loved ones," stated Duncan Mitchell-Innes, a partner and deputy head of private client at TWM Solicitors.
"People typically have a better idea of their future income when they retire, which makes it simpler to determine whether a portion of their estate will be wasted. People can effectively transfer any pension or investment income they don't require with the correct planning. This maximizes their inherited tax-free portion of their estate," he continued.
Giving to a junior Sipp and ISA.
Contributions to another family member's pension from excess pension income are a frequently disregarded option. With comparatively small yearly gifts, those who choose this path could contribute to the development of future millionaires in their family.
"Some people are contributing directly into tax-efficient accounts like Junior ISAs and pensions, instead of just giving cash to their children and grandchildren," stated Chris Etherington, private client partner at the accounting firm RSM.
According to him, "these can allow the gifted funds to grow significantly over decades through the power of compounding, free of tax, potentially creating millionaires of the future from relatively modest annual gifts," he continued.
No matter how much money the child makes, a parent or grandparent can currently contribute up to £9,000 to a Junior ISA and up to £2,880 to a child's pension annually. Because basic rate income tax is deducted from the pension contribution, HMRC tops up a pension contribution at this level to £3,600.
Even if they have not personally contributed to the pension, someone can still profit from this. The growth is maximized because all income and gains in the Junior ISA or pension pot are tax-free. One important determinant of this's potential value is time.
How to tax-free give your grandchildren a £1 million inheritance.
As an illustration, suppose a grandparent contributes as much as they can to a Junior ISA and pension plan established for their newborn grandchild. These contributions would be made annually from the child's birth until the age of 23, at which point many would begin their careers in earnest.
With a 4 percent annual return assumed, the Junior ISA would mature into an adult ISA at the age of 18, and by the time the child turned 23, it would have grown to about 320,000. Up until now, 207,000 would have been the total amount contributed to the Junior ISA.
The ISA pot could be as much as 1.85 million if it were then left unaltered, with no additional contributions, and invested so that it continued to generate an annual return of 4% until the child turned 67.
By contrast, from the total net contributions of 66,240 during that time, the pension would reach about 105,000 by the time the grandchild turned 23. By the age of 67, it might be worth over 607,000 if no additional contributions were made and there was a 4% annual growth. More than £1 million could be in the pension fund if a higher yearly growth rate of 5% could be attained.
Solicitors at the law firm TWM cautioned that it is still very easy to make mistakes, such as giving away too much of your pension income and then using money from a savings account to pay your energy bill.
Mitchell-Innes stated: "HMRC is keeping an eye out for these disparities, so before making a sizable gift, you should get expert advice if in doubt.
"You must maintain meticulous records because HMRC needs a detailed breakdown of your income, expenses, and excess income gifts for each of the seven relevant tax years.
"This must be provided by the executors when submitting the inheritance tax return to HMRC after a person passes away.
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