There has been a sharp rise in people seeking advice on gifting money to reduce inheritance tax (IHT), and it’s easy to see why. With HMRC set to collect a record £8 billion in inheritance tax this year alone, families are looking to take action to protect their wealth.
And the situation is about to become even more severe. From April 2027, the Budget’s proposed changes to IHT will extend to unused pension pots, creating what’s being dubbed a “double death tax.”
The Harsh Reality of Inheritance Tax
Inheritance tax is already one of the most punitive taxes in the UK. It’s charged at a flat rate of 40% on assets above the £325,000 nil-rate band and the £175,000 main residence band for inherited family homes.
For families with pension savings, the new rules will add another layer of complexity – under these changes:
- IHT will be charged on liable pensions at 40% when the policyholder dies. For example, if £100,000 of a pension is subject to IHT, beneficiaries will receive just £60,000.
- Income tax may also apply to withdrawals if the policyholder dies aged 75 or over. Beneficiaries will pay income tax at their marginal rate (20%, 40%, or 45%) on any withdrawals.
So, a basic rate taxpayer would lose an additional £12,000 in income tax on the £60,000 they inherit, leaving them with just £48,000. The total tax burden? 52%.
For higher-rate taxpayers, the outlook is even bleaker. A 40% taxpayer ends up with just £36,000 – a staggering 64% tax charge and additional rate taxpayers lose 67%, leaving just £27,000.
Hidden Penalties and High Tax Rates
The harshness of the IHT system doesn’t end there. Families with larger estates may face further penalties due to the main residence nil-rate band taper. This little-known rule reduces the £175,000 main residence allowance by £1 for every £2 above an estate value of £2 million. Once an estate exceeds £2.35 million, the allowance disappears entirely.
By including pensions in estates for IHT purposes, many more families will fall into this trap and some could face an 84% tax rate on inherited pensions, reminiscent of the high tax rates seen in the 1960s and 1970s.
A System Frozen in Time
The IHT burden has been exacerbated by decades of inaction. The nil-rate band has been frozen since 2009 – a full 15 years – while gifting allowances have remained unchanged since 1981.
This frozen system, coupled with rising property and pension values, is dragging more families into the IHT net every year. So it’s no surprise that many are taking matters into their own hands, looking to gifting as a way to protect their wealth.
Gifting: A Powerful Tool to Save on IHT
Gifting is one of the most effective ways to reduce inheritance tax liability:
- The 7-Year Rule: Gifts are completely free of IHT if you live for 7 years after making them. Even if you don’t, the 40% tax rate reduces on a sliding scale. By year 7, it’s down to just 8%.
- Annual Gift Allowance: Each individual can gift up to £3,000 per year with no IHT liability. Couples can gift £6,000. If you didn’t use last year’s allowance, you can roll it over, doubling the exemption to £12,000.
- Small Gifts Exemption: You can give unlimited gifts of up to £250 per person each year, provided the recipient hasn’t also benefited from your £3,000 annual allowance.
- Wedding Gifts: You can make tax-free gifts to loved ones getting married – £5,000 for a child, £2,500 for a grandchild, and £1,000 for others.
- Exempt Gifts for Living Costs: Contributions to help pay for an ex-spouse, elderly dependent, or child in full-time education may also be free from IHT.
One of the most underused exemptions is the gifts out of surplus income rule. If you can demonstrate that a gift was made from your surplus income and doesn’t affect your standard of living, it’s entirely free of IHT.
Take Action And Keep Records
The key to effective gifting is careful planning and meticulous record-keeping. Document every gift you make, including the amount, date, and purpose. This ensures your wishes are honoured and prevents disputes with HMRC later.
With the right advice, you can take control of your wealth, minimise IHT, and pass on more to the people you care about.
