Did you miss the first part in this Inheritance Tax series. Find out ‘Why Inheritance Tax Matters More Than Ever’ here.
Inheritance Tax (IHT) can feel complicated, but some of the most effective ways to reduce a future tax bill are actually very straightforward. This article explains the key allowances available to you, along with the different types of gifts you can make during your lifetime to make use of these allowances. We’ll also look at the often-overlooked “normal expenditure out of income” rule one of the most powerful tools many people don’t even realise they can use.
1. The Main Allowances Everyone Can Use
The Nil-Rate Band
On death, every person in the UK can pass on £325,000 before any inheritance tax is due. This is called the Nil-Rate Band. If you’re married or in a civil partnership, you can pass on any unused allowance to your spouse when you die. This means that together, a couple can pass on up to £650,000 before IHT becomes an issue.
The Residence Nil-Rate Band (RNRB)
If you leave your main residence to a direct descendant (children, stepchildren or grandchildren), you may benefit from an additional Residence Nil Rate Band (RNRB) of up to £175,000 per person. Like the standard nil-rate band, any unused RNRB can transfer between spouses, allowing a couple to pass on up to £1 million tax-free (when combined with the standard nil-rate band).
The RNRB can only be used against your main home, so if the property is worth less than the allowance, the relief is capped at the property’s value. It also tapers away by £1 for every £2 your estate exceeds £2 million.
2. Your Annual Exemptions (These Refresh Every Year)
These are small allowances you can use each year to reduce the size of your estate over time.
Annual Gift Allowance – £3,000 per year
You can give away up to £3,000 a year without it counting towards your estate. You can split this between as many people as you like. If you didn’t use last year’s £3,000 allowance, you can carry it forward and use it this year, but only for one year.
Small Gifts – up to £250 per person
You can give up to £250 to any number of people each tax year. This is a simple way to pass on money to family members, friends or grandchildren without affecting other allowances.
Wedding or Civil Partnership Gifts
You can give larger gifts when someone gets married or enters a civil partnership:
- Up to £5,000 to a child
- Up to £2,500 to a grandchild or great-grandchild
- Up to £1,000 to anyone else
The gift must be made before the ceremony, and the wedding must actually take place for the exemption to apply.
3. Outright Gifts – The “7-Year Rule”
You can give away as much money as you like at any time, provided you survive for seven years afterwards. These gifts are known as “potentially exempt transfers”.
If you live for seven years after making the gift, it becomes fully exempt from inheritance tax. If you die within seven years, the gift may still reduce the size of your taxable estate, depending on its value and how long ago it was made.
4. Gifts Out of Normal Expenditure – One of the Most Useful (and Least Used) Rules
Many people don’t realise that you can give away regular amounts from your income, fully exempt, as long as certain conditions are met. This rule is incredibly powerful for those who have more income than they need.
To qualify:
- The gifts must come from your income (for example, pension income, employment income or investment income). Drawing from savings does not count as income for this purpose
- The gifts must be regular, for example, a monthly payment, a termly school fee, or an annual transfer to a child or grandchild.
- After making the gifts, you must have enough income left to maintain your normal standard of living.
There is no limit on how much you can give under this rule, as long as it meets the criteria. Which makes it one of the most effective ways to reduce the size of your estate naturally over time.
And Finally…
As part of your ongoing planning, we will continue to review your use of allowances and gifting opportunities during your regular meetings to ensure everything remains aligned with your goals. If you have any friends, family members, or colleagues who might also benefit from understanding how these allowances could support their own financial plans, please feel free to pass this information on. We’re always happy to help them review their position and explore their options.
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