Making the most of Inheritance Tax exemptions

There are many exemptions and reliefs from Inheritance Tax. Many people are familiar with the nil-rate band (NRB) of £325,000 and the residence nil-rate band (RNRB) of up to £175,000. However, there are a number of Inheritance Tax (IHT) exemptions and reliefs that can significantly reduce or eliminate tax on gifts made during lifetime or upon death that often go unused. Key lifetime exemptions include the annual £3,000 gift allowance, the £250 small-gift rule, wedding/civil-partnership gifts and regular gifts out of ‘surplus’ or ‘excess’ income. On death, the major exemptions are spouse exemption and charity exemptions.

Gifts made more than 7 years before death

Gifts made to an individual is a Potentially Exempt Transfer (know as a PET). If a person survives for 7 years after making the gift, it is exempt from Inheritance Tax.

Example: Mandy makes a gift of £500,000 cash to her daughter on 5 July 2025. Mandy dies on 1 August 2032, just over 7 years after making the gift. The gift is free of Inheritance Tax as it is more than 7 years after she made the gift.

If that person dies within 7 years, the value of the gift uses their Nil Rate Band (Inheritance Tax free allowance). If the gift is in excess of the Nil Rate Band, resulting in IHT being due on the gift then taper relief may reduce the IHT rate depending on when that person died.

Example: Mandy makes a gift of £500,000 cash to her daughter on 5 July 2025. However, this time Mandy dies on 1 August 2030, just over 5 years after making the gift. £325,000 is free of Inheritance Tax and the remaining £175,000 is subject to Inheritance Tax. The effective rate of Inheritance Tax on the gift is reduced to 16% as Mandy died between 5 and 6 years after making the gift. This means IHT of £28,000 is due compared to £70,000 that would be due if the rate was 40%.

Annual Inheritance Tax exemptions

Planning for Inheritance Tax starts during lifetime. Below we are list three lifetime exemptions from Inheritance Tax.

1. Annual exemption

Each person may give away up to £3,000 worth of gifts in each tax year free of IHT. This £3,000 annual allowance can be used as one gift or split among recipients. Any unused amount can be carried forward one tax year. Potentially, this means that if no gifts were made in the previous year, up to £6,000 can be given in the next year. Source: gov.uklitrg.org.uk

Example: Brenda didn’t make any gifts in tax year 6 April 2022 to 5 April 2023. Brenda can give up to £6,000 in tax year 6 April 2023 to 5 April 2024.

2. Small gifts (£250 rule)

You can make unlimited small gifts of up to £250 to each individual recipient each tax year. This exemption applies per recipient and cannot be combined with the £3,000 allowance for the same person.

Example: Priti could give £250 to ten different friends in a year (£2,500 total) and all gifts will be free of Inheritance Tax provided none of those friends also received part of the £3,000 annual allowance that year or any other gift.

Main Exemptions

There are two main exemptions to Inheritance Tax

Spouse and civil partner exemption

Transfers between married couples or civil partners are exempt from IHT. Note that the position changes if the spouses or civil partners have different domicile / residence for IHT purposes.

Charitable donations

Gifts to UK registered charities are fully exempt from IHT. Also, if at least 10% of the net estate is left to charity, the IHT rate on the remainder is reduced from 40% to 36%. Due to way the calculation is made, in some cases it may be possible to increase the charitable gifts to 10% without reducing the amount passing to your beneficiaries.

Special cases

A few very narrow exemptions apply only when an individual dies. Notably, certain fatality payments or pensions received by families of armed forces or emergency service personnel killed on active duty are exempt. Further information about these exemptions can be found in our article Inheritance Tax Exemptions for Emergency Responders and Service Personnel.

Three often overlooked Inheritance Tax exemptions

1. Gifts on marriage or civil partnership

There are additional allowances available for weddings or civil partnerships. These marriage gifts are in addition to the annual £3,000 exemption although it is important to note they cannot be combined with the small-gifts £250 exemption for the same person). The tax free amount depends on the relation to you and the wedding gift allowances are as follows:
i. £5,000 to a child
ii. £2,500 to a grandchild or great-grandchild
iii. 1,000 to any other person, provided the gift is made before the wedding. These marriage gifts are in addition to the annual £3,000 exemption (though they cannot be combined with the small-gifts £250 exemption for the same person)

Example: Peter gifts his son Jonathan £3,000 on 30 April 2024 and a further gift of £5,000 on 20 June as a wedding gift. Both gifts are free of Inheritance Tax.

2. Gifts to political parties

Any gift to a UK political party is IHT-exempt if the party meets certain criteria. The party must have had at least two MPs at the last general election, or one MP and at least 150,000 votes. If eligible, any amount given is outside the donor’s estate. For example, a legacy to one of the major UK parties in a will would not incur IHT.

3. Gifts out of surplus income

This is perhaps the most overlooked exemption and there were only 480 claims were made in 2021/22. There is no limit to the amount of gifts can be made from surplus income provided they meet the requirements. The conditions are that the gifts must:
i. Be part of the donor’s “normal expenditure” (a habitual pattern)
ii. Come from post-tax income
iii. Leave the donor with enough income to maintain their usual standard of living

Example, David receives a generous pension and has £30,000 left over each year after paying his usual bills. He supports his two children by giving them £1,000 a month each while they are at university. These gifts are from his surplus income and are free of Inheritance Tax.

Practical tips for keeping on top of Inheritance Tax

1. Keep clear records of all gifts made including the amount, name of recipient and the date the gift was made.
2. Plan early. 7 years doesn’t sound like a long time but in the event of a life limiting illness, it can quickly become a challenge
3. Take advice from a professional. If IHT is a concern, taking professional advice is essential to ensure you claim everything you are entitled to and don’t miss anything important.

Contact us for further advice

Our solicitors specialise in advising on Inheritance Tax and often work closey with other professionals such as financial advisors. To book a free initial consultation, please call us on 01260 769 639. We offer appointments at our Congleton office or in your own home. Alternatively, meetings can be carried out online (e.g. via Teams).

Our solicitors will be happy to advise you on your options.

This article does not constitute legal advice and we recommend you take advice from a solicitor before taking any action.