Inheritance Tax Tips & and Other Lifetime Gifting
Posted: 1st November 2022
I recently sat down for a chat about the Wills, Trusts and Probate Team, and in particular advice on inheritance tax (IHT) as part of our “Tea with EMG” series (video below). We talked about some of the ways in which people can make gifts during their lifetime by way of IHT planning, some of which are summarised below. While we covered a lot of gifting possibilities, I managed to run out of time to talk about one of the most effective options – the potentially exempt transfer, or “PET”. Making a PET is an opportunity for an individual to make really quite large gifts without any IHT liability and is definitely worth exploring if you are concerned about IHT.
Before embarking on any IHT planning, it is sensible to make sure you fully understand the IHT rules which are in place. The allowances which are available for IHT, the amounts which an individual can pass to beneficiaries on their death before IHT is payable, are fairly generous. Provided certain conditions are met, a married couple can potentially pass up to a £1m to their family and other beneficiaries before any IHT is payable. If a couple’s combined estate will fall under that threshold, it is likely they do not need to be overly concerned with IHT planning during their lifetime. However, if you are concerned about IHT, making a PET (or several!) can be a very effective way of mitigating your IHT liability.
PETs
A PET is a gift which can be made by an individual to another individual (or a trust for vulnerable or disabled persons, but not other trusts where different rules apply). Even if no other IHT exemptions apply to the gift, it may still potentially escape any charge to IHT.
A PET can be of unlimited value; it does not matter the value of cash or other assets which are gifted, there is no immediate IHT charge as a result of making the gift. This means there is scope to gift very sizable amounts without incurring any IHT, and with the result of reducing the value of your estate which will be subject to IHT on your death. However, the donor cannot be certain that the gift will be free of IHT until seven years have passed from the date of the gift, at which point it becomes fully exempt – this is the “seven-year clock” which so many people are aware of, but is often misunderstood.
If the donor were to die within seven years of making the gift, then it would become chargeable to IHT and will use all or part of the donor’s nil rate band (NRB). This is the amount an individual can give away during lifetime or on their death where IHT is charged at 0%, i.e. it is free of IHT. The current NRB is £325,000.
For PETs with a value of less than an individual’s NRB, if the donor dies within seven years of making the gift, then the PET will use up that amount of their NRB. There will be no IHT to pay on the gift, but the balance of the NRB available for use on the donor’s death will be reduced, perhaps to almost nothing. This may mean that there is more IHT to pay on their estate than had been expected, and the burden of that IHT will lie with the estate rather than the recipient of the PET.
Where the value of a PET exceeds the NRB, if the donor dies within seven years the gift will use up the entire NRB so there is none remaining for use in relation to the donor’s estate. IHT will be payable on the value of the PET which exceeds the NRB, and will be the responsibility of the recipient of the gift.
As a side note, when making a PET it is therefore prudent to consider whether the recipient of the gift would be able to meet any IHT liability, should it arise. If there are concerns about this, or if the donor would not want the recipient to pay the tax, then there are steps which can be taken. For example, insurance policies are available which would provide cash to pay any IHT which arose. Alternatively, the donor may wish to amend their Will to specify that IHT on any failed PETs is payable from their estate.
The longer the donor survives after making the gift, provided they survive for at least three years, the lower the IHT which will be payable on any PET which exceeded the available NRB. This is known as “taper relief” and is calculated as follows:
| Period between date of gift and death of donor | Rate of taper relief applied to amount of IHT | Effective rate of IHT | ||
| 0 – 3 years | 0% | 40% | ||
| 3 – 4 years | 20% | 32% | ||
| 4 – 5 years | 40% | 24% | ||
| 5 – 6 years | 60% | 16% | ||
| 6 – 7 years | 80% | 8% | ||
| Over 7 years | 100% | 0% |
The concept of taper relief causes great confusion, but much of this can be avoided by bearing in mind that taper relief:
- Is applied to the IHT due, not to the value of the gift.
- Is only available where the value of the PET exceeds the NRB (i.e. where IHT becomes payable following the donor’s death); it does not apply to all PETs. If there is no IHT to pay in relation to the gift because its value was less than the NRB, there will be no taper relief.
It is also possible to make gifts to trusts (other than trusts for vulnerable persons) which in some cases would be preferable to an outright gift to an individual, but to do so would be a Lifetime Chargeable Transfer rather than a PET. Different tax rules apply to Lifetime Chargeable Transfers, most significantly that there would be an immediate IHT charge of 20% on any gift over the NRB in force at the time, but they merit their own extended discussion – perhaps a topic for another blog!
Other options for lifetime gifting
If you are likely to face an IHT liability on your death and would like to take steps to mitigate this, there are quite a lot of options, many of which are available to anyone and do not require expensive financial or legal advice. My episode of the Tea with EMG series provides a general overview of some of the most common IHT planning possibilities.
Things to think about
It is, of course, important to be cautious, particularly with larger gifts, to ensure you fully understand the effects and possible risks of what you are doing. In particular, you need to be satisfied that you can afford to give away any assets without undermining your financial security; it is a great thing to be able to make gifts during your lifetime to help family members or friends, but we would never advise someone to do that if it could adversely affect them and their ability to maintain their standard of living during their lifetime.
We would always recommend taking specialist advice before embarking on IHT planning, particularly where you are considering making gifts of significant value. If you have any questions or would like to have an initial conversation about your potential IHT liability and whether you might benefit from undertaking estate and inheritance tax planning, I or another member of the team would be very happy to have an initial conversation with you.
Please get in touch on either 0191 500 6989 or email us at [email protected]. Alternatively, you can visit our website for more information www.emgsolicitors.com