The UK’s “most hated” tax is facing a major shake-up, with families warned that the Government may soon limit how much they can gift their children tax-free before death.
Inheritance tax (IHT), charged at 40 per cent on estates above £325,000, currently allows unlimited lifetime gifts made at least seven years before death.
But Rachel Reeves is reportedly considering a lifetime cap on these tax-free gifts, aiming to plug a hole in public finances by tightening one of the most widely used tax-planning strategies.
At present, gifts given less than seven years before death can face a tapering tax rate between 8 per cent and 40 per cent, but the proposed changes would allow the Treasury to target money passed down many years in advance.
The move is designed to capture more wealth stored in assets such as rapidly rising property values.
Here, we take a look at the existing IHT loopholes which more may wish to take advantage of, should the lifetime gifting cap change.
Using discounted gift trusts or loan trusts with investment bonds is a smart way to reduce IHT while still keeping access to funds.
These are legal structures designed to hold assets outside your estate, often for the benefit of your heirs, while allowing you to retain some financial access during your lifetime.
A discounted gift trust involves gifting a lump sum into a trust but keeping the right to regular withdrawals. The value of that retained benefit is excluded from your estate immediately, and the rest may fall outside your estate after seven years, depending on how long you live.
A loan trust, by contrast, involves lending money to the trust rather than gifting it. The original loan stays in your estate, but any growth on the invested funds is held in the trust – and therefore outside your estate for IHT.
In both cases, these trusts let you support your beneficiaries while efficiently managing your exposure to IHT.
David Stirling, financial adviser and director of Mint Wealth Ltd, said he was seeing these methods increasingly used, noting that bonds are a favoured choice because they offer steady income and flexibility for such planning.
Buying annuities
Looking ahead, Mr Stirling expects more people to buy annuities with their pensions instead of using drawdown, especially if gifting rules are tightened in the upcoming autumn Budget, as many predict.
He explained: “That’s because the value of an annuity immediately falls outside their estate for IHT purposes.”
Annuities offer a regular guaranteed income in retirement.
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The simplest way to reduce IHT is to gift money to loved ones well in advance, Zoe Dagless of Meliora Financial Planning said.
The current rules mean that gifts must be given at least seven years before death to avoid a tax charge
“Gifting lets the younger generation use the money sooner, whether to spend or invest, which can help boost the economy and support things like getting on the housing ladder, she added.
She also pointed to the £3,000 annual gifting allowance, which can be passed on each year tax-free. If unused, it can be carried forward one year, so couples could potentially gift £12,000 over two years without triggering IHT.
However, she warned that a new lifetime cap on gifts could make it harder for families to pass on wealth efficiently.
“I do question how some of the younger population will be able to get on the housing ladder if the lifetime cap on gifts is small.”
Separately, one of the most powerful exemptions applies to transfers between spouses or civil partners, Rachael Griffin, tax and financial planning expert at Quilter, said.
He added: “Transfers between spouses or civil partners are entirely free from IHT, regardless of the amount or timing. And any unused IHT allowance can be transferred to the surviving spouse, potentially doubling their threshold.”
Regular gifts out of income
There is also the ability to make gifts out of surplus income, Ms Griffin said.
If you have income left after covering your usual living expenses, you can gift this to family or friends without it counting towards your estate for IHT purposes.
She said: “This can be a highly effective way to provide ongoing financial support, such as helping with school fees or regular living costs, while reducing the eventual tax liability.”
Rowan Morrow-McDade, director of Alexander & Co Chartered Accountants, agreed that this is a good way to avoid paying the charge – which about one in 20 estates in the UK pay, according to Government figures.
He said: “You can gift any amount of money, on a regular basis so long as it is from your income to an individual. This is also not a potentially exempt transfer, so even if you die within seven years, the gift does not become chargeable.”
We could see more individuals choosing to leave the UK, taking their assets with them if rules are changed by the Chancellor, Mr Morrow-McDade said.
He explained there is now a “tail” where when you leave the country, you are still within scope of UK IHT for a number of years. But if you are relatively young, you are likely to “outlive the tail”, he said.
Gifting to charities
Gifts to charities, political parties and certain national institutions such as museums and universities are fully exempt. Ms Griffin said: “If 10 per cent or more of your estate is left to charity, the overall IHT rate on the remainder can drop from 40 per cent to 36 per cent.”
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