How lifetime gifting and trusts can reduce Inheritance Tax

With upcoming changes bringing most unused pension funds and pension death benefits into scope for Inheritance Tax (IHT) from 6 April 2027, it may be appropriate to explore other potential estate planning opportunities.

Gifting assets and using trusts during your lifetime can offer the potential to begin such planning, however, tax rules are complex and the correct option depends on your circumstances. Such planning should be done in conjunction with a wider review of estate planning, including a review of your Will and any potential IHT charges on death.

Lifetime gifting

A lifetime gift is any cash or asset you give through the course of your life. A gift is defined as anything with value and also includes the difference in value if you intentionally sell something for less than it is worth. Lifetime giving can reduce your estate and your IHT liability when you die, with some gifts falling out of your estate immediately, as they fall under certain exemptions, including:

• Spouse or civil partner exemption – gifts between spouse and civil partners are generally exempt from IHT provided they are domiciled in the UK.
• Charitable exemption – Gifts made to registered UK charities are exempt from IHT.
• Small gifts exemption – You can give gifts of up to £250 to any number of individuals in a tax year, provided you have not used another Inheritance Tax exemption for a gift to the same person.
• Wedding & civil partnership gifts – Each parent can gift up to £5,000, each grandparent up to £2,500, and anyone else can give up to £1,000 to the couple and IHT does not need to be considered. Specific conditions apply.
• Annual exemption – You can give up to £3,000 each tax year with no IHT considerations. This exemption can also be carried forward for one tax year if it is not used.
• Normal expenditure out of income – Provided you can demonstrate that you have annual excess income and are able to continue your current standard of living without dipping into your capital, a cash gift made to another individual as part of a settled pattern of expenditure will be fully exempt from IHT. This is a generous exemption but it is important to keep records of the gifts and of the pattern of giving.
• Reliefs – There are specific reliefs which may apply where you are gifting certain types of asset, predominantly those which qualify as business assets. These are not covered by this article.

Any gift which is not covered by these exemptions is considered to be potentially exempt from IHT at the time it is made, and provided you survive seven years it will fall out of your estate completely. If you do die before the seven years and the total value of gifts you have made in the previous seven years is above the current £325,000 nil-rate band, the rate of IHT due to be paid reduces depending on the amount of time that has passed.

Using trusts

A trust provides for the separation of legal and beneficial ownership and can be useful where, for example, you want younger family members to have access to income within parameters set by the terms of the trust and the trustees. It is typically established by a written deed but a trust can be created without those formalities. An example of this would be a nominee bank account opened on behalf of grandchildren. Young grandchildren may not be able to legally open a bank account, so a grandparent could open it on their behalf. The grandparent therefore has legal ownership of the account, but the money in it beneficially belongs to the grandchildren. That is the simplest type of trust.

Formal trusts can cover lots of different scenarios, but all non-tax favoured lifetime trusts created since 22 March 2006 are known as relevant property trusts and have their own IHT regime. That regime means that the trust will be potentially charged a maximum of 6% IHT every ten years, although the actual charge is likely to be lower.

An individual can gift up to the nil-rate band into a lifetime trust every seven years without incurring an immediate IHT charge. Currently £325,000 can be put in without any IHT. If spouses jointly settle a trust this can allow £650,000 of value to be added without an immediate IHT charge.

That gift does, however, go onto the seven-year IHT clock, meaning the individual needs to survive the gift by seven years. If they were to transfer in more than £325,000, there would be an up-front 20% lifetime inheritance tax charge.

Where a formal trust is set up, it is important to ensure that you take the appropriate legal advice.

We’re here to help

It is important to review estate planning arrangements regularly, especially following changes in family circumstances, asset values or tax legislation.

If you would like to discuss how lifetime gifting or trusts could fit into your estate planning, please get in touch with a member of our team.