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Thinking about giving a financial gift? Gifting can become complicated when you consider how that can affect your inheritance tax position. Our financial planning expert, Shona Lowe, looks at the main things to think about and gives you some quick tips.

Helping loved ones with financial gifts is important to many of us, both in our lifetime and beyond. In our recent Class of 2022 report, 10% of the people we surveyed said they’d already started gifting friends and family to reduce their inheritance tax bill. But 77% didn’t feel very confident about how they should pass their wealth on.

It’s important to carefully consider how much you can afford to gift, who you’d like to make those gifts to and how you’d like that gift to be made. Gifting in your lifetime could help reduce inheritance tax. But it’s important to understand the tax landscape to make sure your gifts are effective and make use of the various exemptions and allowances available.

What counts as a gift when it comes to inheritance tax?

When it comes to inheritance tax, a gift is anything that removes value from your estate. So this could be anything that forms part of your estate - money, property, investments or valuables. And it doesn’t just include giving something away. It can also include selling something for less than it’s worth. For example, if you sell your car to one of your children for less than its value, the difference in value is considered a gift.

And one that can trip people up - if you give something away but continue to use it afterwards, the value of it could still be in your estate for inheritance tax purposes. For example, if you give your car to one of your children but continue to drive it on a regular basis.

But just because something you do counts as a gift for inheritance tax purposes doesn’t necessarily mean you’ll have to pay inheritance tax on it, either at the time it’s made or when you pass away. Whether any inheritance tax is due will depend on the type of gift you make, where the gift goes to, how long you live after making the gift and the overall value of your estate.

Some gifts are free from inheritance tax

There are some gifts which are free from inheritance tax, both at the time you make them and in the future. And the amount you gift leaves your estate straightaway. These are called exempt gifts:

  • Anything that you give to your spouse or civil partner
  • Gifts you give to charities or political parties
  • Gifts of up to £250 (as long as each gift goes to a different person and it’s the only exempt gift they’ve had from you in that tax year). This will commonly include birthday and Christmas gifts given from your regular income
  • A wedding gift from a parent to their child of up to £5,000, from grandparent to grandchild of up to £2,500, or up to £1,000 to someone else

Each tax year you also have what’s known as an annual exemption. Under this you can give away money or items of property to the value of £3,000. This can all go to one person or be shared between several people. And if you didn’t use that exemption in the previous tax year, you can use it in the current tax year and give away £6,000.

You can make regular payments

Known as ‘normal expenditure out of excess income’, you’re able to make regular payments from income you don’t need to maintain your normal standard of living. For example, if you wanted to pay a loved one’s rent or mortgage, or make regular payments into a savings account for your grandchild.

There isn’t a limit on how much you can give away and, like the exempt gifts above, the amount you gift will leave your estate straightaway. But you must be able to afford the payments after your regular living costs and without having to cut back. Plus the payments need to come from your normal monthly income.

If you wanted, you could combine regular payments with your annual exemption in the same tax year so that one person can receive even more.

It’s important to carefully consider how much you can afford – although you may not need the money now, your circumstances in the future could change.

You can gift lump sums, but there may be inheritance tax payable

If you can afford to, you can also give away lump sums of cash, investments or assets, for example a flat you own that you rent out or money you’ve saved up. Whether making one of these gifts, will mean you have to pay inheritance tax when you make the gift or in the future depends on where the gift goes to, how much it is and how long you survive after making it.

If it’s a gift to an individual, regardless of how much it’s for, you won’t have to pay inheritance tax when you make the gift. But your estate may have to if you die less than seven years later and the gifts you made in the seven years before you died are more than the nil rate band you have. For most people, this nil rate band is £325,000.

If it’s a gift to a trust, you’ll have to pay inheritance tax when you make the gift if it’s more than your nil rate band. And your estate may have to pay again if you die less than seven years after making the gift.

Think about keeping a gift-giving record

Keeping a record of the gifts you give is essential. It helps you show which are exempt and which may have to be included as part of your estate. And in the event of your death, it will also help those responsible for the administration of your estate when it comes to claiming any allowances and working out if there’s tax to pay.

How to estimate your inheritance tax bill

The rising value of property and the fact that inheritance tax allowances have been frozen for some years means that more people are potentially going to be leaving their loved ones with an inheritance tax bill.

If you’re worried about the impact of inheritance tax on your loved ones, a simple starting point is to understand the value of your estate and therefore your likely bill. Once you have an idea of what you’re dealing with, it’s easier to make a plan to reduce the potential impact, for example by gifting.

  • Add up your assets – Your home, other property, cars, motorhomes, boats, cash savings and investments. Don’t forget to include life insurance that pays out to your estate when you die, anything you’ve inherited, as well as any gifts you’ve made in the last seven years. If you’re married or in a civil partnership, you and your partner should do this separately and half the value of any joint assets.
  • Consider loans/debts – Calculate any loans or debts you may owe. That includes any mortgages (just your share of them), personal loans, credit card debts or overdrafts, plus funeral costs.
  • Calculate what you owe – Subtract the total value of your loans and debts from your total assets.

If you’re single, deduct the nil rate band (currently £325,000) and multiply the answer by 40%.

If you have a spouse or civil partner, add your estate values together and then deduct your combined nil rate band (currently £650,000) and multiply the answer by 40%.

This gives an estimate of your likely inheritance tax liability. Remember that this is just a guide. It may not consider all factors relevant to your individual circumstances.

Need help with gifting or inheritance tax?

Careful planning is important to help look after your wealth now, and to make sure that you and your loved ones get the maximum benefit from that wealth, both in your lifetime and beyond.

If you have any questions about gifting or inheritance tax, getting professional financial advice can give you peace of mind. A financial adviser will go through all the options available and work with you on a tailored plan.

Find out more about how abrdn can help you manage your wealth, or book a free, no-obligation call with one of our expert financial planners.

The information in this article should not be regarded as financial advice. Information is based on our understanding in May 2022. Tax rules can always change in the future. Your own circumstances and where you live in the UK could have an impact on tax treatment.