Inheritance tax planning and tax-free gifts

Updated: 04 Apr 2023

Find out how to give away money from your estate to reduce your inheritance tax bill, and what is a 'potentially exempt transfer'

Inheritance tax planning and tax-free gifts - Which? (1)

Danielle Richardson

Inheritance tax planning and tax-free gifts - Which? (2)

In this article

Can I give money away to avoid inheritance tax?
Tax-free gifts in numbers
Who can I give money to tax-free?
How the annual exemption works
Which gifts are tax-free?
'Potentially exempt transfers' for inheritance tax
What is inheritance tax 'taper relief'?

Can I give money away to avoid inheritance tax?

If your estate is worth more than £325,000 (or £650,000 for married couples and civil partners), some of it may pass to HMRC in inheritance tax when you pass away.

One of the most straightforward ways to avoid inheritance tax is to consider giving away assets while you are still alive.

You're allowed to gift some of your money away each year without any tax being due after your death. This includes gifts to your spouse or civil partner, or if you'd like to leave money to a charity.

It usually also includes gifts to individuals made more than seven years before your death.

Tax-free gifts in numbers

The list below explains some of the key details for making tax-free gifts. However, this can be a tricky area so it's worth speaking to a professional for advice on your specific circ*mstances.

£0 - The amount of tax due on gifts to your spouse or civil partner
Seven - Number of years you have between gifting something to an individual that isn't your spouse and your death to ensure it's tax-free
£3,000 - The total amount you can gift tax-free in a tax year (your 'annual exemption')
£250 - Maximum amount you can gift tax-free to an individual that hasn't benefited from your annual exemption each year
£0 - Amount of tax due on gifts given for maintenance of old or infirm relatives
18 - The age up to which you can gift your children with maintenance for their education or training tax-free
£5,000 - The amount a parent can gift their child tax-free for their wedding
£0 - Amount of tax due on gifts to charities or political parties.

Who can I give money to tax-free?

Gifts to your spouse or civil partner

These gifts are usually tax-free. This doesn't include unmarried partners.

You can find out more in our guide to inheritance tax for married couples and civil partners.

Gifts to your family or other individuals

If you wish to leave money to other family members, such as your children, it's a good idea to plan how you want to do this.

Some gifts are best to give while you're still alive rather than leave in your will. Most gifts to people made more than seven years before your death are tax-free (they must be to people as opposed to trusts or businesses).

These gifts are called 'potentially exempt transfers', because tax might be payable, depending on whether you survive seven years after making the gift. Potentially exempt transfers are explained further below.

Another way to gift money to your children is through a mortgage deposit, but you should take independent advice before going ahead with this.

Find out more:How does family income benefit insurance work?

Gifts that benefit you

If you give something away but still benefit from it (a 'gift with reservation'), it will still count towards the value of your estate.

For example, if you give away your home but continue to live in it rent-free until your death, you'll be deemed to be the beneficial owner, and it will still be taxed as part of your estate when you pass away.

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How the annual exemption works

The annual exemption means you can give up to £3,000 away tax-free during each tax year.

You can also carry any unused annual exemption forward to the next tax year - but you can only do this for one tax year. So, if you didn't use this allowance last year, you could give away a total of £6,000 this year - but you won't be able to carry forward last year's unused annual exemption to the next tax year.

As a couple, that means you'll usually be able to give away £6,000, and potentially £12,000 if you didn't make any substantial gifts the year before.

Find out more: What are the different types of life insurance?

Which gifts are tax-free?

You can give any number of gifts up to £250 to a single recipient, but not to anyone who has already benefited from your annual exemption.

Gifts out of income may also be tax-free. This means you can give money from your salary or pension and it won't count towards your inheritance tax. The gift must be from income, so you couldn't sell assets to give away the profit without a potential future tax bill looming over the recipient.

According to HMRC, these gifts need to form some sort of regular spending pattern. That doesn't mean you need to commit to gifting recurring large sums, but one-off amounts are unlikely to qualify. A good rule of thumb is it will likely qualify if the gift is from your current account.

If any relatives are currently dependent on you for maintenance because of old age or infirmity, these gifts are also tax-free. This would also include an ex-husband, ex-wife or ex-civil partner.

Gifts for the maintenance, education or training of your children aged 18 or under (including step and adopted children) are also exempt from IHT.

'Potentially exempt transfers' for inheritance tax

Most gifts you make to other people during your lifetime (unless they fall into the list of tax-free gifts) are classified as 'potentially exempt transfers', or PETs for short.

If you survive for seven years after making the gift, no inheritance tax is due. However, if you die within this time, the gift will be considered part of your estate for inheritance tax purposes.

Generally PETs are applied to your £325,000 tax-free allowance before the rest of your estate. So, unless you've given gifts worth more than this allowance, the recipients are very unlikely to pay inheritance tax .

However, if much of the tax-free allowance has been used up against PETs and taxable lifetime gifts, this can leave little or no allowance to be used against the rest of the estate.

Find out more:inheritance tax thresholds, rates and who pays

What is inheritance tax 'taper relief'?

Even if tax does become due on a gift, the tax may be reduced because of 'taper relief'.

The table below explains how taper relief can reduce tax due on potentially exempt transfers (PETs):

Number of years between gift and death	Rate of IHT on the gift
0-3 years	40%
3-4 years	32%
4-5 years	24%
5-6 years	16%
6-7 years	8%

While taper relief may reduce tax on PETs if you die within seven years of making them, it won't reduce the tax due on your estate as a whole.

If that seems complex, consider the following examples, all of which involve trying to pass on £600,000, partially as gifts and partially as a final estate.

Anne gives away £100,000 in March 2013, but died in April 2018, leaving a £500,000 estate.

Anne doesn't live seven years after making the gift, so it's reassessed as part of her estate.

The £100,000 PET is deducted from her £325,000 allowance, meaning there is £225,000 still to be used against her remaining £500,000 estate.

The remaining £275,000 is taxed at 40%, resulting in a £110,000 inheritance tax bill.

Bill gives away £400,000 in March 2013, and then passes away in April 2018, leaving a further £200,000.

When he dies, the PET is reassessed, and his £325,000 personal allowance is used against the £400,000 gift.

Because the gift is in excess of the allowance, and he survived for more than five years after making the gift, the taxable part of this gift incurs a tapered 16% rate, meaning a £12,000 tax bill for the recipient.

The remaining £200,000 estate is taxed at 40%, leaving a further £80,000 inheritance tax bill.

In total, £92,000 is paid in inheritance tax, saving £18,000 compared with the first example.

Charlie gifts £400,000 in March 2010, and then passes away in April 2018, leaving a further £200,000.

When he dies, the PET is deemed successful, as it was made more than seven years before he died. The gift is exempt from inheritance tax, and there is no further inheritance tax consequence.

What's more, the £200,000 remaining estate falls within the £325,000 allowance - so there is no tax to pay there either.

In total, nothing is paid in inheritance tax, saving £110,000 compared with the first example.

Diane makes multiple potentially exempt transfers, giving £200,000 in March 2013 and £200,000 in March 2015. She passes away in April 2018, leaving a final £200,000.

The £325,000 is first offset against the first £200,000 gift, leaving £125,000 to be offset against the second £200,000 gift.

This leaves £75,000 which is taxed at 32%, as she had lived for more than three years after making it. This generates a £24,000 tax bill, for the second recipient.

The remaining £200,000 is taxed at 40%, resulting in another £80,000 tax charge.

In total, IHT runs to £104,000, still saving £6,000 compared with the first example.

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