Ask Jenny Ross: How much can I give away to limit risk of inheritance tax?

Fewer than four per cent of all deaths in 2019-20 (around 23,000) resulted in a bill for inheritance tax

ANSWER: As Gareth pointed out, inheritance tax rules are fiendishly complex so I’ll start by recapping the basics: if your estate is worth less than £325,000, there will be nothing to pay to HMRC.

If you leave your home to a child or grandchild, you get a further allowance of £175,000. This takes your total tax-free allowance to £500,000, or £1m for a couple.

Inheritance tax receipts totalled £5.2bn in 2019-20, yet this came from a relatively small number of estates. Fewer than four per cent of all deaths (around 23,000) resulted in a bill, but the 40 per cent tax rate means that these bills can be substantial.

You can reduce what your heirs might have to pay by giving away assets in your lifetime – just bear in mind that there are limits to the amount you can give away tax-free. These include your ‘annual exemption’ of £3,000 per tax year, which you can give to any number of people, as long as the total amount gifted remains below £3,000.

You can also make an unlimited number of tax-free gifts worth up to £250 each, but not to anyone who has benefited from your £3,000 annual exemption.

If your child is getting married or starting a civil partnership, you can give them up to £5,000 tax-free as a wedding gift. For grandchildren, the limit is £2,500, and for any other couple it’s £1,000.

Then there are gifts out of income. As you point out, these too can be exempt from inheritance tax but the rules are quite different to the gift allowances I’ve just run through.

There is no set limit to the amount you can give away from income, but other strict criteria apply. Crucially, the gifts must be paid out of surplus income – in other words they can’t have any impact on your standard of living. They must also be part of your ‘normal expenditure’ and paid on a regular basis. The examples HMRC gives on its website include paying rent for your child and giving financial support to an elderly relative.

A word on semantics: ‘normal’ in this context means normal for you and not for the average person. ‘Income’ can include earnings from employment and pensions as well as savings interest, dividends and rental payments. Payments from insurance policies are usually treated as capital payments and so wouldn’t qualify for the exemption – neither would gifts of shares, jewellery or other ‘capital assets.’

HMRC will be looking for a ‘pattern of giving.’ If you die soon after starting to make payments, there will need to be evidence that these were genuinely intended to be the first of many. For that reason, it’s worth stating your intentions in writing when you start making the payments.

As part of its assessments, HMRC will consider the amount given, the frequency of the gifts, the nature of the gifts and who’s receiving them. They don’t necessarily need to be monthly payments – for example, you might make gifts from income to your children on their birthdays every year as well as at Christmas. These would form a pattern of giving.

The amount doesn’t always need to be the same either. HMRC says that regular gifts should be ‘comparable in size’ but acknowledges that some sources of income can be variable (such as dividends from shares), as can the specific costs you might be covering through regular gifts (such as grandchildren’s school fees).

Because the judgement on whether gifts qualify as normal expenditure out of income will be made when you’re no longer around, it’s sensible to keep a written record of all the gifts you make each tax year to make it easier for executors to report these to HMRC (using a form called ‘Gifts and other transfers of value’, schedule IHT403, if you want to look it up) and to deal with any challenges.

Jenny Ross is editor of Which? Money