With inheritance tax (IHT) bills rising fast, giving financial gifts to your loved ones early could be a great way to reduce your inheritance tax bill.
Last tax year, IHT revenues hit a record high of £8.2bn, according to new HMRC figures.
And recent budget changes could drag thousands more into the tax net: from April 2027, pension wealth will be subject to inheritance tax for the first time.
It’s a major shift that’s expected to affect 153,000 estates between then and March 2029, according to OBR figures.
With more of us due to pay inheritance tax over time, passing on wealth early could help you save a big tax bill down the line.
How is inheritance tax changing?
Pension wealth is currently exempt from inheritance tax, but from April 2027, it will be counted as part of your estate when you die, along with your other assets.
It’s a significant change that could see pension savers paying thousands more on wealth they pass on to their loved ones.
Final salary pensions won’t be affected – the change impacts those of us who have a defined contribution pension, where you build up a pension pot to spend during retirement.
This shift will push even modest earners into paying IHT for the first time. The tax-free nil-rate band stands at £325,000, so a family inheriting a house worth £300,000 and a pension pot of £150,000, could end up owing £50,000 inheritance tax.
How can giving gifts reduce your bill?
With inheritance tax bills increasing, giving gifts to your loved ones during your lifetime is one of the simplest ways to reduce your inheritance tax bill. But you need to watch out because any gifts you make within seven years of your death could still be subject to inheritance tax, landing your relatives with a bigger tax bill than expected.
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Ian Dyall, head of estate planning at wealth manager Evelyn Partners, explains: “The overriding rule is, along as you live for seven years you can give away as much as you want, as at that point any gift will be counted as having left the estate and will be exempt from IHT. But the important caveat here is that you cannot continue to benefit from the gift after having given it away. However, there are also certain exemptions which mean that the amounts gifted leave the estate immediately.”
There are several allowances that allow you to give smaller regular gifts without the risk of an IHT bill if you die within seven years.
Giving regular small gifts
Giving small regular gifts is one of the most tax-efficient ways to pass on wealth.
Here’s a summary of the rules:
- You can give away £3,000 each tax year, and it won’t be counted as part of your estate when you die as it falls within the annual gift allowance
- You can give multiple small gifts of up to £250 each year to anyone, provided you haven’t used another allowance for the same person
- When a relative gets married, you can give extra gifts – £5,000 to your children, £2,500 to your grandchildren and £1,000 to anyone else
All these gifts will be free from IHT, even if you die within seven years.
Giving gifts from excess income
In addition, there’s a little-known rule that can pack a big punch when it comes to IHT planning – it’s known as “gifts out of surplus income.”
It allows you to give away money from your surplus regular income – someone who takes home income of £40,000 but spends £30,000 would have £10,000 “surplus income”.
Ian Dyall explains that, “This must be treated with care as it is bound by tight rules and needs to be well recorded, but essentially means that you can give away regular amounts if they come out of excess income (and only income) that is not needed by you to maintain your standard of living.”
Depending on your income and expenses, this rule could allow you to give away more than £3,000 each year, saving a big IHT bill down the track. But you do need to keep careful records to prove the gifts came from your surplus income.
Not keeping records could mean your relatives end up paying IHT on any gifts you made within seven years of your death.
Writing a tax-efficient will
In addition to making lifetime gifts, it’s vital to have a will that reflects your current wishes. Consulting with a solicitor can provide valuable guidance on inheritance tax and how to optimise available allowances.
Yet worryingly, more than half (53 per cent) of UK adults aged 50–64 don’t have a will, according to the Money and Pensions Service. That means more potential stress for relatives, as there are no clear instructions about where their money should be distributed.
Louise Cardwell, partner at Ashtons Legal, emphasises the importance of expert advice from a specialist solicitor on inheritance tax matters. They focus on “helping clients reduce their tax liability through tailored legal strategies such as trusts, lifetime gifts, and tax-efficient wills. This is especially important after any budgetary changes,” she added.
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