Lifetime gifts can be a tax-efficient way to give away wealth during your lifetime without it being included within your estate and subject to inheritance tax. Our guide helps explain the rules and inheritance tax implications.
What is a lifetime gift?
A ‘lifetime gift’ is where cash or assets are given away during a person’s lifetime. The effect of such gifts is to remove value from that person’s estate. As such, lifetime gifts can reduce the amount of inheritance tax due after death and are often used as part of inheritance tax planning. Gifts between spouses and to charities are usually made tax-free, regardless of the circumstances. However, in order for other gifts to successfully mitigate inheritance tax, certain criteria must be met, which we will look into further below.
There are two types of lifetime gift:
- potentially exempt transfers, and
- gifts with reservation of benefit.
What are ‘potentially exempt transfers’?
If the person making the gift (the donor) survives for seven years after giving away an asset then, no matter what the value is, it will be exempt from inheritance tax and classed as a ‘potentially exempt transfer’. For this to be the case, however, the person who died must not have continued to make use of the asset after it had been gifted. Such a situation would fall under the second lifetime gifts category – gifts with reservation of benefit.
How long before death does a potentially exempt transfer need to be made to be exempt from inheritance tax?
The donor must survive for at least seven years in order for the gift to be exempt from inheritance tax. Should they die before this time has elapsed, the beneficiary may be liable for tax on the gift at 40%. If the donor does die within those important seven years of making a gift, however, the inheritance tax payable may be reduced, depending on when the gift was made. See tapered relief below.
What are ‘gifts with reservation of benefit’?
This category covers gifts where the person who died gave away an asset and then continued to enjoy the use of it – for example they continued to live in a property rent-free that they had given away ownership of.
The seven-year rule does not apply to gifts with reservation of benefit. The asset will still be treated as part of the estate and subject to inheritance tax. It must be valued at the date of death and HMRC must be notified.
What does the executor need to do regarding lifetime gifts?
The executor must determine whether there were any lifetime gifts made prior to death that need to be included in the estate. They may need to talk to friends and family and consult paperwork such as bank statements to do this. If they find that lifetime gifts have been made within seven years of the death, or that gifts with reservation of benefit have been made, they must inform HMRC.
As a beneficiary, do I need to disclose a lifetime gift?
Yes, if beneficiaries deliberately fail to tell executors about receiving any lifetime gifts, they may be charged a severe penalty by HMRC on top of any tax liability due.
At what date is the asset valued for lifetime gifts?
Where a gift with reservation of benefit is added to the estate, it is the value as at the date of death that is included to the list of assets.
Where a lifetime gift is a potentially exempt transfer but has failed because the donor died within seven years of making it, it is the value at the date the gift was made that is included in the estate.
How do you make a lifetime gift?
There is no specific way that a lifetime gift must be made. A bank transfer or cheque is better than cash as there will then be a clear record of the transaction. You can also bestow a gift by transferring property such as a home or car. It is always sensible to document a gift, whether formally by deed, or simply in writing. This can help avoid disputes that it was a loan.
Can I make a lifetime gift to a trust?
Trusts can be used to ring-fence money for beneficiaries without giving up complete control of the asset. Lifetime gifts can successfully be made into trusts. However, trusts are complex, and expert advice is always required.
Inheritance tax: what is the current nil-rate threshold and rates?
Everyone has a tax-free inheritance tax allowance of £325,000. This is known as the ‘nil-rate band’ and hasn’t changed since the 2010/11 tax year. For anything in your estate over the £325,000 threshold, the standard inheritance tax rate applied is 40%. (However, married couples/ civil partners are allowed to pass possessions and assets to each other tax-free in most cases.)
What is the residence nil rate band?
The residence nil rate band was introduced by the Government to enable an additional amount to be passed on tax-free against the value of a family home. As of April 2020, the nil rate band stands at £175,000 that can be passed on before tax becomes due. The tax savings offered can be substantial, but the rules can be complicated so it is important to seek expert advice.
What is taper relief?
Taper relief applies if the total value of any gifts made within seven years prior to death exceeds the inheritance nil-rate allowance (i.e. over £325,000). Inheritance tax is payable on the following scale:
|Gifts made less than 3 years ago
||100% of the inheritance tax is payable on the gifts – 40%
|Gifts made 3-4 years ago
||80% of the inheritance tax is payable on the gifts – 32%
|Gifts made 4-5 years ago
||60% of the inheritance tax is payable on the gifts – 24%
|Gifts made 5-6 years ago
||40% of the inheritance tax is payable on the gifts – 16%
|Gifts made 6-7 years ago
||20% of the inheritance tax is payable on the gifts – 8%
|Gifts made 7+ years ago
||No inheritance tax is payable
What about inheritance tax exemptions?
The amount of lifetime gifts to be added to the estate after death can be reduced by making use of certain inheritance tax exemptions prior to death.
- Annual exemption – £3,000 can be given away each tax year.
- Small gift exemption – Gifts of up to £250 each can be made to as many people as the donor wishes, provided no other gifts were made to these recipients.
- Wedding and civil partnership gifts – These gifts are subject to limits depending on the relationship with the recipients and can range up to £5,000.
- Regular gifts made out of excess income – Such gifts must be made on a regular basis and must leave sufficient income for the donor to maintain their usual standard of living.
Can you challenge a lifetime gift?
Just as a will can be contested, a lifetime gift can also be challenged if you do not feel it was made for the right reasons or that it was in accordance with the wishes of the donor. Grounds for challenging a lifetime gift include:
- if the donor didn’t have sufficient mental capacity to make it
- if someone with power of attorney over the donor’s financial affairs made the gift on their behalf without the approval of the Court of Protection
- if the donor was subject to undue influence
- if the gift was the result of fraud.
Gifts can also be challenged if they were intended to evade the law in some way, such as to stop creditors taking part of the estate to settle debts once the person has died.