Every Christmas, many older family members choose to swerve the present-selection minefield with financial gifts to their young relatives.
This year, financial gifts might be more popular than ever as parents, grandparents and older relatives grapple with new inheritance tax rules.
Ian Dyall, Head of Estate Planning at wealth management firm Evelyn Partners, says, ‘Helping out loved ones and seeing them enjoy greater financial security can bring a lot of joy and satisfaction to all concerned, at any time of year. Sharing wealth and supporting relatives financially has become more of a priority as demands have mounted on the budgets of students, young families and even middle-aged adult children.
‘Another reason financial gifts could be top of the list for some families this Christmas, and in the coming years, is that older savers are looking to pass on more wealth before they die.
‘The IHT rule changes announced in the Budget mean that more families will be drawn into the scope of inheritance tax in the coming years, and some of those will need to take steps shortly if they want to mitigate the effects.’
In her first Budget at the end of last month, Chancellor Rachel Reeves announced that defined contribution pension pots will be included in estates’ inheritance tax liabilities from April 2027, and she also froze the nil rate bands for an extra two years, until April 2030.
The Chancellor also reduced agricultural property relief and business property relief will also be reduced from 2026. The first £1mn of combined business and agricultural assets can still be passed on tax-free, but IHT will be levied at 20 per cent on the rest. A 20 per cent rate will also apply to AIM shares.
The Office of Budget Responsibility estimates that an extra 1.5 per cent of total UK deaths will become liable to pay IHT as a result. That’s 10,500 out of around 213,000 estates with inheritable pension wealth in 2027 to 2028. Further to this, 38,500 estates will pay an average £34,000 in additional IHT because pension assets are to be included in the value of the estate.
Dyall says: ‘IHT will only apply to assets if the estate is not covered by available nil-rate bands and other reliefs – so before anyone starts giving money away for this reason they should take advice or do their homework on what exemptions they are entitled to, and therefore what the IHT liability is likely to be.
‘If it looks like their estate will be subject to inheritance tax, a sensible option for some can be to give away assets while they are still alive because it could save their beneficiaries a potential charge of 40% on taxable assets at death, or even more as pensions become exposed. For this to be successful though, the gifts must meet IHT rules.
‘Smaller gifts might be covered by the annual gifting exemptions, while larger gifts will probably be subject to the seven-year rule as “potentially exempt transfers” [see below].
‘But retirees must make sure they can afford generous gifts. Are they leaving themselves enough to fund the life they want, and to cover things like care costs? Estate planning is often a trade-off between tax savings and keeping access to funds for unexpected future needs, and this is where trusts can come in useful.
‘All other things being equal, the changing IHT rules will make lifetime gifting more attractive, especially for those with big defined contribution pension pots.’
Gifting excess pensions cash
Dyall says: ‘The new IHT rules will encourage more older savers to draw down on their pension pots and use the funds in lifetime, whether that is for their own financial needs, or those of their loved ones.
‘Families will especially want to avoid a situation where pension funds are “double taxed”. Under current rules, if the pension holder dies at age 75 or older, the beneficiary could also be charged income tax at their marginal rate as they withdraw funds from the pension pot that has already been subject to IHT.
‘There is a consultation in place on how the pension IHT rule will be enacted, but as it stands this threatens a potential effective tax rate of 67% for the beneficiary of pension assets if they are an additional rate taxpayer, which means that those approaching or beyond age 75 might be looking to give away pension cash. In cases where an estate larger than £2million starts to lose their residence nil-rate band the potential tax penalty is even greater.
‘Even those who are still building up pension pots rather than drawing on them might cease their contributions in the light of the new rules and decide, for instance to start building up a pension for a loved one instead.
‘But don’t be too blinded by IHT as most donors will be paying tax on pension withdrawals. Could you be paying a higher rate of income tax by increasing pension withdrawals for gifting, which could wipe out any eventual IHT saving? This is obviously a danger if the pension withdrawals are subject to the higher 40% or 45% marginal rates of income tax.
‘Moreover, those thinking of taking substantial amounts from their pension must be happy that they are selling investments at an acceptable price. If the markets are in a downturn you could be realising paper investment losses.
‘There are potentially tax-efficient ways to gift from pension funds. One would be to take the 25% tax-free lump sum, if still available. The gift of such a sum would probably be subject to the seven-year rule before clearing the estate altogether, so we might see some savers accelerate the withdrawal of their TFLS to set the seven-year clock ticking.
‘If the benefactor were not to survive seven years, then the gift would only benefit from a lower rate of IHT thanks to taper relief if its value exceeds available NRBs – otherwise it will simply be added to the estate.
‘Another would be to take regular withdrawals from the pot as income, in order to make gifts using the “normal expenditure from income” rule [see below]. Such regular gifts could be free of IHT (as long as they meet the rules) and the pension withdrawals could be managed to avoid paying excessive income tax.
‘One neat tax-efficient way of using excess pension income would be to start or increase funding of a pension for a loved one, who could be a partner, adult child or grandchild. If the recipient does not have an income, you can pay up to £2,880 into their pension in each tax year, topped up to £3,600 by basic-rate government tax relief.
‘Even if they do earn and pay into a pension already, the extra funding will result in an extra gain in tax relief, and that is likely to be more beneficial to them, than leaving assets at death that could be taxed not just once but twice.
Gifts from pension money will be subject to the same IHT rules as gifts made from other assets:
The annual gifting exemptions
Dyall says: ‘A growing number of estates are finding themselves just the wrong side of the nil rate bands, which have been frozen for 14 years, and that number will grow over the coming years as the NRBs will remain unchanged until April 2030. So even modest lifetime gifts within these annual limits could come in useful both by avoiding an IHT bill and also by saving executors and beneficiaries the rigmarole and expense of settling IHT before probate.’
Gifts of any value between UK domiciled spouses and civil partners are free from tax. Gifts to other individuals will leave the estate immediately and be free of IHT as long as they meet the following conditions:
- Total gifts made by you in a tax year total less than £3,000 – or £6,000 for a couple. You can also carry forward any unused £3,000 allowance from the previous tax-year, making financial gifts of up to £6,000 possible this Christmas – or £12,000 for a couple.
- Small gifts of up to £250 can be made to any number of people in the tax year, provided the total to any one person does not exceed £250. If it does, this exemption does not apply and all gifts would start to use up the aforementioned £3,000 allowance
- Gifts out of regular income that are part of normal ongoing expenditure can also be made (see below for more detail)
- Money can also be given as a gift tax free in the event of a marriage or civil partnership amounting to £5,000 from each parent, £2,500 from each grandparent and up to £1,000 from any other person. These would not use up any of the other allowances
Gifting from surplus income
‘Regular gifts made by people with more income than they need may benefit from the ‘normal expenditure from income’ exemption,’ says Dyall.
‘This is a much-overlooked option for transferring wealth tax-efficiently, Many donors like to give ongoing regular amounts to young relatives, for instance into a savings or investment vehicle – such as a Junior ISA, pension or trusts. But to be IHT-efficient, regular gifts must meet certain rules.
‘To qualify, the gifts must be “regular” in nature, made from income rather than capital, and cannot affect the donor’s standard of living. This will not help if you only intend to make a one-off gift, but for those who are accumulating savings from excess income, gifting some each Christmas can be a tax-efficient way of helping younger family members.’
Seven-year rule and potentially exempt transfers
Larger one-off gifts can be made, and they should leave the estate as long as the donor then survives for seven years and retains no benefit from or interest in them. During that time such gifts remain ‘potentially exempt transfers’.
Dyall says: ‘Generally, the best time to gift if you can afford it is now. The earlier you gift, the more chance there is of that gift becoming fully exempt.’
If the donor dies within seven years, the nil-rate band is reduced by the value of the gifts, and tax on assets above the NRB will be due at 40%. But if the gifts put together exceed the nil rate band then taper relief can apply, which reduces the tax paid on older gifts.
If there were three-to-four years between date of gift and death, the IHT rate lowers to 32%, while at six-to-seven years the rate falls to just 8%. All of which means that large gifts exceeding the nil rate band can moderate IHT liability even if the gifter does not survive for seven years.
Dyall adds: ‘On the other hand, this does mean that a big gift could leave a surprise for beneficiaries who find that they owe tax on it if the gifter does die within seven years. If a gift above the NRBs does become liable for IHT, it is the recipient who will have to pay the bill, and even though they might get taper relief, they may not have the resources to meet the tax bill, possibly having spent the money.
‘If a gift is below the nil-rate bands, and the donor dies within seven years, then all the beneficiaries of the estate could share the liability on the lifetime gift received by one person, which can lead to a different set of difficulties.’
The use of trusts – and bare trust vs JISA
Dyall says: ‘Many people are reluctant to give up substantial parts of their wealth in case emergency or late-life expenses arise, like care home fees. Others fear that if they gift away their wealth, their relatives might spend the money unwisely, render it inaccessible or have to surrender it in a divorce.’
This issue can be addressed by using trusts – and two types are of particular interest.
Dyall says: ‘A discretionary trust can allay some concerns that a beneficiary might squander assets, or lose them through divorce or a business insolvency – or simply to limit access until a child is mature enough to use it wisely. The beneficiary will be listed as one of several possible beneficiaries and will only benefit at the trustees’ discretion, so the trust can protect the assets, and the timing and size of any payments made from the trust can be controlled.
‘Each person can gift up to the £325,000 nil rate band into discretionary trusts in any seven-year period without triggering an IHT liability. Gifts exceeding this will be immediately liable to IHT at 20% with further tax due if they die within seven years.
‘Alternatively, a bare trust can also be useful, particularly where grandparents wish to invest for grandchildren. When investing for minor beneficiaries, the natural instinct is to use tax-beneficial wrappers such as a Junior ISA, but these are limited in size and can’t be accessed before age 18, even for the child’s benefit,
‘If a grandparent invests for a grandchild using a bare trust, the invested amount is unlimited and money from the trust can be used for the child’s benefit before 18 if required. The investments are taxable, but it is the minor beneficiary who is liable, and their personal income tax and capital gains tax allowances usually eliminate any liability on smaller investments.
‘While bare trusts can be as tax efficient as a JISA but less limiting, anti-avoidance legislation does exist where the money is provided by a parent rather than a grandparent. If the income exceeds £100 the income is taxable against the parent. The JISA has a slight tax advantage for parental investments as they are not caught by these measures.’
