3 tax-efficient ways to gift wealth during your lifetime and reduce your Inheritance Tax liability

When you’re organising your wealth, one of your priorities may be working out how you can most effectively support the next generation of your family.

You might want to ensure that your children have what they need to enjoy their own retirement, for example. Or, you might want to support your grandchildren with a large purchase, giving them funds to put toward a deposit for a first home.

In the past, you might have chosen to leave this wealth in your will, allowing your loved ones to benefit when you passed away. But now, “giving while living” has become a far more common strategy, with UK adults passing on assets during their lifetime.

In fact, according to IFA Magazine, there has been a 48% surge over the last 10 years in families distributing wealth before their passing.

This could be an effective strategy for you, gifting wealth now to see the benefits that it brings your loved ones. Furthermore, it could help you reduce a potential Inheritance Tax (IHT) charge that they may face when you pass away.

However, it’s important to be aware of the rules around gifting for IHT purposes so you don’t fall foul of them.

Read on to find out how IHT works, and three tax-efficient ways for you to gift wealth to your loved ones.

Your loved ones may face a tax bill if your estate exceeds certain thresholds

It’s first important to understand how IHT works and the circumstances under which your loved ones may face a charge.

Before IHT is due, you can pass on a certain amount of your estate tax-free. This is known as the “nil-rate band”, and stands at £325,000 in 2024/25.

You may also benefit from the additional residence nil-rate band if you pass your main residence to your direct descendants (that is, children, grandchildren, and so on, including adopted children). In 2024/25, this stands at £175,000, taking the total amount you could potentially pass on tax-free to up to £500,000.

Furthermore, your spouse or civil partner will inherit any unused nil-rate bands when you pass away, and vice versa. So, if you’re married or in a civil partnership, you could pass on up to £1 million between you before tax is due.

However, any value exceeding these thresholds is potentially chargeable for IHT at a rate of 40% as standard. This is a hefty tax charge, and one that could put a significant dent in the wealth your loved ones receive.

3 tax-efficient ways to gift wealth

As IHT could eat into the wealth you want to pass on to your family, this is where gifting can be powerful. By gifting wealth now, you can put it in the hands of your chosen beneficiaries, while reducing the size of your taxable estate for IHT purposes.

In doing so, you can ensure your loved ones receive their inheritance and cut down the size of a potential bill that they’d face on your death.

But, before you start passing on wealth to reduce the size of your estate, it’s first important to understand the rules around gifting and IHT. Otherwise, your loved ones could face an unexpected bill when you pass away, even if you and they think you have done everything correctly.

These three methods below could allow you to tax-efficiently gift wealth and reduce IHT.

Remember: no matter which methods you choose or how you make gifts, it’s crucial to keep accurate records of what you have given, to who, and when. That way, your executors (that is, the people who will be responsible for valuing your estate) know what is and isn’t liable for IHT.

1. Use your annual gifting exemption

Each tax year, you can gift wealth under your annual gifting exemption and have it automatically fall outside your estate. In 2024/25, the exemption is up to £3,000. Combined with your spouse or partner’s exemption, that means you could pass on up to £6,000 in a single tax year.

You can carry forward unused exemption for one tax year, allowing you to gift up to £6,000 in a single year individually, or up to £12,000 as a couple.

Making use of this exemption each year could allow you to reduce the size of your estate over time, while putting that wealth in your chosen beneficiaries’ hands.

Aside from your annual gifting exemption, you can also make other tax-free gifts. For example, you can make IHT-free gifts to people who are getting married, depending on their relationship to you. In 2024/25, you can gift up to:

• £5,000 to a child
• £2,000 to a grandchild
• £1,000 to anyone else.

Furthermore, you can make an unlimited number of small gifts of up to £250 each to as many people as you like.

Bear in mind that you can’t make a tax-free £250 gift to someone who you’ve made a gift to under another exemption.

2. Make potentially exempt transfers

There’s a common misconception that once you’ve used your gifting exemptions, you can’t gift any more wealth without your loved ones facing an IHT charge.

This isn’t actually quite accurate. In reality, any gifts in excess of these allowances and exemptions are actually “potentially exempt transfers”, or “PETs”.

When you make a PET, it only becomes tax-free if you survive the gift by at least seven years. If you die within seven years of making the PET, there may be IHT due. The rate of tax your loved ones will face may depend on a sliding scale known as “taper relief”, determined by how soon you passed away after making the gift:

So, even if you have used your gifting exemptions, you may be able to gift more wealth tax-efficiently. Even if you pass away within seven years, it might still mean your loved ones are better off as they could face a lower rate of tax.

Bear in mind that any wealth gifted as a PET will be the first part of your estate assessed against your nil-rate band. If your PETs are covered under your nil-rate band, there will be no taper relief.

3. Gift wealth from surplus income

A lesser-used but potentially powerful way to tax-efficiently gift wealth is to use the “gifting from surplus income” rule.

Under this rule, you can gift wealth directly from your income to whoever you’d like, and it will fall outside of your estate immediately. In theory, this is up to an unlimited amount.

There are three key criteria that your gifts must meet for them to be considered IHT-free under this rule:

1. The gifts must be regular, and you must be able to prove that they are part of your regular expenditure.
2. The funds you gift must come from income – such as employment earnings or pension income – rather than from savings or other types of capital.
3. You must be able to maintain your standard of living. For example, the gift must not affect your ability to pay your bills.

One way you could use this rule, for instance, is to pay for a grandchild’s school fees, as these would constitute a regular payment that you could make from your income.

If you would like to explore gifting from surplus income, it’s important to speak to an experienced professional. Otherwise, you may fall foul of these rules and inadvertently leave a bill for your loved ones.

Get in touch

Want to find out more about organising your wealth for the benefit of your loved ones? Get in touch with us at Caliber Financial Management.

Email contact@caliberfm.co.uk or call 01525 375286 to speak to our team today.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate estate planning, tax planning, or will writing.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.