It's good to gift, but be aware of the tax traps

Gifting can be a great way of passing on wealth to your loved ones as well as reducing the value of your estate for Inheritance Tax (IHT) purposes and general estate planning.

Considering how to gift is vital when thinking about long term wealth protection. For example, student loans can attract an extortionate rate of RPI + 3%. As inflation surges one of the best investments you might make could be to help younger family members pay them off.

Although it is good to gift, there are some tax considerations to be aware of.

Chargeable transfers

There is a common misconception that IHT is a death tax. Indeed when an individual dies they are treated as making a chargeable transfer equal to the value of their assets at the date of death.

However, if an individual makes a lifetime gift, the value transferred by that gift may also be chargeable to inheritance tax.

The most common form of chargeable transfer is a gift to a trust. Although this may be a useful tool in protecting wealth and managing your IHT exposure, it can result in an immediate lifetime IHT charge.

Potentially exempt transfer (PET)

If a gift made is neither a chargeable transfer nor an exempt transfer, it is classed as a "potentially exempt transfer" (PET). This is treated as an exempt transfer while the donor is alive and will only become chargeable to IHT if the donor dies within seven years of making the gift.

Making a gift during your lifetime and surviving those seven years is a common form of IHT planning.

Impact on the nil rate band (NRB)

Every individual has a nil rate band (NRB) of £325,000. This can be used against lifetime chargeable transfers, failed PETs on death that come back into charge, and against the death estate, prior to an IHT charge.

If, however, you make gifts during your lifetime that aren't covered by your tax-free gift allowances, and you die within seven years of making the gifts, the value of these gifts will reduce or eliminate your NRB, meaning less of your estate will be passed on tax-free. It is worth remembering however that the rate of IHT applied to gifts made more than 3 years before death are lower than the rate applied on death.

There are however some exemptions and allowances which allow gifts to be made without being subject to IHT (even if you do not survive seven years).

It is therefore sensible to utilise the tax-free gift allowances as much as possible first.

The following gifts can be exempt from IHT, regardless of whether you survive seven years:

  • You can give away £3,000 each tax year (the annual exemption) and, you can also use any unused allowance from the previous year.
  • You can gift up to £250 to any one person in a tax year, as long as you have not used another allowance on the same person
  • Each tax year an individual can give a tax-free gift to someone who is getting married or entering a civil partnership. This can be up to:
    • £5,000 to a child
    • £2,500 to a grandchild or great-grandchild
    • £1,000 to any other person
  • Gifts out of income - A lifetime gift is exempt from IHT if the donor can satisfy HMRC that it constitutes "normal expenditure out of income". "Normal" in this case means habitual or typical – i.e. a gift that happens every year.

The gift will be treated as having been made out of the donor's income if the donor is left with sufficient income to maintain his normal standard of living.

This exemption would apply to life assurance premiums or personal pension premiums paid by an individual in respect of another person, or to regular small gifts of cash as Christmas or birthday presents.

  • Gifts to spouses/civil partners - the transfer of any asset by an individual to his or her spouse or civil partner either during lifetime or on death, is completely exempt from IHT. The only exception to this is if the donor spouse or civil partner is UK domiciled and the recipient spouse or civil partner is not domiciled in the UK. In this instance, only the first £325,000 of the transfer is exempt from IHT.

There can also be capital gains tax (CGT) implications of making lifetime gifts unless the gift is of cash or an exempt asset (please see below).

Capital Gains Tax (CGT) implications of gifting

When considering gifting an asset, be aware that a gift constitutes a disposal for CGT purposes. Unless the asset gifted is specifically exempt (for example cars), most property other than cash in Sterling is an asset for CGT purposes.

Most individuals have a CGT annual exemption, currently £6,000 (reducing to £3,000 in April 2024). The CGT annual exemption is similar to the personal allowance for income tax in that the first £6,000 of capital gains in the year are not chargeable to CGT.

Anything over this may be subject to either 10% and 18% if you are a basic rate taxpayer, or 20% and 28% if you are a higher rate taxpayer (with the higher rates for each type of taxpayer applying to residential property and carried interest).

In addition, transfers between spouses and civil partners take place at no gain or loss (unless separated and not living together), which means that assets can pass freely between them, without incurring a charge to CGT. Gifts to charities are treated in the same way. So an individual may wish to consider transferring some assets, or part of an asset, before a disposal, to utilise a spouse or civil partner's annual exemption if they are not already using it.

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