Gift-related inheritance tax bills have affected thousands of households

In the past four years, thousands of families who made larger gifts have been hit with an inheritance tax bill

New Freedom of Information (FOI) data shows that between 2020-2021 and 2023-2024, over 5,000 estates paid over £1 billion in inheritance tax on lifetime gifts.

According to data obtained from HMRC by financial advisory firm NFU Mutual, 1,390 estates paid 315 million in inheritance tax on lifetime gifts in 2023-2024 alone, or an average of 226,000 per estate.

The annual exemption and small gifts allowance are examples of annual inheritance tax gift allowances.

Additionally, you can donate any amount of money, and if you pass away seven years or more after making the gift, there is no inheritance tax due; however, if you pass away within that time frame, there may be an IHT.

These gifts are referred to as potentially exempt transfers (PETs); view the full video here.

According to NFU Mutual, families are giving assets or money to loved ones in an effort to lower their IHT exposure. This trend is expected to pick up speed as the majority of unused pension pots will be included in estates starting in April 2027. However, if you wait until it's too late to give gifts, your loved ones may end up with a sizable IHT bill.

"Many people start thinking about inheritance tax planning later in life, leaving less time for the seven-year clock to run," said Ade Babatunde, senior financial planning director at wealth management company Rathbones.

We often encourage families to begin planning earlier than they believe necessary for this reason."

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Your 325,000 tax-free allowance is consumed first by gifts made within the seven years prior to death; any portion beyond that is subject to tax tapering.

NFU Mutual chartered financial planner Sean McCann used the example of a person who gave a non-exempt gift of £100,000 and passed away six years later. As a result, their IHT-free allowance would drop to £225,000, and their beneficiaries would not be required to pay IHT on the gift.

However, the first 325,000 would eat their tax-free allowance and the remaining 100,000 would be charged according to the sliding scale if the gift was worth 425,000 and the recipient passed away six years later.

Since the gift was made six to seven years prior to death, the tax rate in this case would be 8 percent on the 100,000 (8,000) instead of the usual 40 percent.

The beneficiaries would have no remaining tax-free allowance to use against the remainder of the person's estate once the 325,000 tax-free allowance was eliminated.

In what other ways can gifts be used to reduce inheritance taxes?

A number of allowances are exempt from inheritance tax.

The first is the annual exemption, which allows you to donate up to £3,000 to one or more individuals each tax year.

The exemption may be carried forward for one tax year if it was not utilized in the prior year.

Babatunde from Rathbones stated, "This allows an individual to gift up to 6,000 immediately."

As long as you haven't used another exemption, like the annual exemption, you can also give smaller gifts of up to £250 to as many people as you like each tax year.

Furthermore, grandparents can give a grandchild who is getting married or entering into a civil partnership 2,500, while parents can give up to 5,000 to a child getting married or entering into a civil partnership.

Even if you are not a parent or grandparent, you can still donate £1,000 to someone who is getting married or forming a civil partnership.

Any other allowance may be added to this wedding allowance, but not the small gift allowance.

"This can be an effective opportunity to pass wealth at an important stage of life for families with multiple children or grandchildren," Babatunde stated."

The gifting out of surplus income rule is another way to give gifts; for IHT purposes, any gifts made under this rule fall outside of your estate.

There is no cap on the amount you can give using this method; however, the gifts must be part of a regular pattern, be financed by income rather than capital, and not lower your standard of living.

"This can be one of the most effective ways to reduce inheritance tax exposure for retirees who receive more pension, rental, or investment income than they actually spend," Babatunde stated.

"Making sure the gifts are appropriately recorded and that sufficient records are kept is a challenge."