Families and individuals who ‘gift’ money to their children, grandchildren, friends or others need to be aware of the complex rules surrounding gifting and Inheritance Tax (IHT).
In England and Wales, IHT is levied at a rate of 40 per cent of an estate’s total value – but only if the estate exceeds the tax-free threshold or ‘nil rate band’ of £325,000, which each individual is entitled to.
One way of reducing IHT is to gift money to friends and family throughout your lifetime – but the rules governing IHT and gifting are notoriously complex and confusing.
Each individual is entitled to a £3,000 annual ‘gift allowance’ – meaning that gifts up to this amount will always be tax-free. However, anything above this threshold could attract IHT, depending on when the donor dies.
Simply put, there is a ‘seven-year rule’ in place governing gifts, which sees financial gifts to friends and family worth more than £3,000 only go IHT-free if the donor survives for seven years after passing on the money.
Each time an individual makes a gift, this will be classed as a ‘potentially exempt transfer’ for IHT purposes – which basically means that if the donor dies within seven years, the exemption will no longer apply.
More confusingly, the rate of IHT incurred might reduce to a lower rate depending on the total value given away in the seven years (which could in fact be 14 years in certain limited circumstances) before the donor passed away.
Outside of potentially exempt transfers, however, individuals are also entitled to a number of other gift-based allowances which will never attract IHT, such as ‘wedding gifts’ of up to £5,000 for a child, £2,500 for a grandchild or £1,000 for anyone else.
In any case, specialist advice is always crucial when it comes to complex IHT matters.