Benefits of lifetime gifting and using trusts
Although the recent Autumn Budget brought no changes to the headline rate of inheritance tax (IHT), there was an announcement that agricultural and business assets with a value of more than £1m will no longer receive 100% IHT relief from 6 April 2026. This will mean that any of these assets which are worth over £1m will only receive a 50% relief, and an effective 20% IHT rate. You can find out more about the possible impact of this on the agriculture sector in our previous insight.
These announced changes mean more estates will need to pay IHT which has understandably caused some concern, however, there are ways to mitigate the impact of these changes.
In addition, there are also new rates in effect relating to capital gains tax (CGT). For any disposals made on or before 29 October 2024, higher rate taxpayers and trustees would have paid tax on any gains from the sale of residential property at a rate of 24% and on other chargeable assets at 20%. From 30 October 2024, all gains realised by higher rate taxpayers or trustees will be taxed at 24%. Lower rate taxpayers will now be taxed at 18% on all gains, the previous rates were 18% on the sale of a residential property, and 10% on other chargeable assets.
In this article, we will explore the interaction between IHT and CGT and steps that can be taken to pass on wealth tax efficiently during lifetime.
Lifetime giving
A lifetime gift is any cash or asset given by an individual across the course of their 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 be a useful way of reducing your estate and ultimately your IHT liability when you die, with some gifts falling out of an individual’s estate immediately, as they fall under certain exemptions, including:
- Spousal exemption – An unlimited amount of gifts can be made to a spouse or civil partner without needing to pay IHT provided they are domiciled in the UK.
- Charitable exemption – Gifts made to registered UK charities are exempt from IHT.
- Small gifts exemption – Gifts valued at up to £250 can be given to an unlimited number of individuals provided no other gifts were made to them.
- Wedding & civil partnership gifts – Parents can gift up to £5,000, grandparents up to £2,500, and anyone else can give up to £1,000 to the couple and IHT does not need to be considered.
- Annual exemption – Up to £3,000 can be gifted 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, any cash gift made is fully exempt from IHT, e.g. paying part of your child’s rent.
Any gift not covered by these exemptions is considered to be potentially exempt from IHT at the time it is made, and provided you survive 7 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 £325,000 tax-free threshold, the rate of IHT due to be paid tapers depending on the amount of time that has passed.
Time between gift and death | IHT rate on the gift |
Under 3 years | 40% |
3 - 4 years | 32% |
4 – 5 years | 24% |
5 – 6 years | 16% |
6 – 7 years | 8% |
7+ years | 0% |
It should be noted if you gift an asset but still benefit from it, that will still be included within your estate for IHT purposes, e.g. you gift a car to your child, but still drive it on a regular basis.
Another important note is that a lifetime gift of a chargeable asset such as a property or a valuable painting is a deemed disposal at market value for CGT purposes. For example, if you wanted to gift a rental property to your children, you would be treated as disposing of it at market value.
Some ways of mitigating the CGT liability include:
- Claiming gift hold-over relief – If eligible, this relief allows the payment of CGT to be deferred to the new owner of the asset so that they would need to pay it when they dispose of it.
- Using clogged losses – If you have gifted an asset previously to an individual which resulted in a loss, you could gift a further asset to the same individual and the loss would be offset against the gain.
- Consider using a trust to shelter the future growth in value of an asset.
Using trusts
A trust is a vehicle that provides for the separation of legal and beneficial ownership. It is typically established by a written deed but you can create a trust without even knowing that you've done it to a certain extent. 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 most simple type of trust that can be in existence.
One of the reasons for using a trust is the availability of CGT holdover relief for any asset, not just business assets. The capital gains tax can be deferred, possibly enabling you to gift chargeable assets in your lifetime without incurring a CGT charge. There can also potentially be inheritance tax savings. All non-tax favoured lifetime trusts created post March 2006 are known as relevant property trusts and have their own inheritance tax regime. That regime means that the trust will be charged a maximum of 6% inheritance tax every 10 years, however, the actual charge may be considerably lower. Although there is a quasi IHT liability within trusts, it is likely to be considerably lower than having a 40% charge on assets worth more than £325,000 on death.
An individual can gift up to the nil rate band into a lifetime trust every seven years without incurring an immediate inheritance tax charge. Currently £325,000 can be put in without any inheritance tax, or 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 inheritance tax 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.
Using life assurance
As noted above, it is possible that gifts made during an individual’s lifetime, either directly to others or into trust, remain within the IHT net for a number of years. It is often worth considering taking out an insurance policy for the amount of IHT that might be at stake.
Life assurance can be a cost-effective way to provide a tax-free lump sum, ensuring that funds are available to pay the IHT liability which can be due within six months of the end of the month in which death occurs. This can be a tight timescale especially if assets require to be sold in order to provide funds to pay the tax.
A life assurance policy may be used to provide life cover for a fixed term (for example 10 years) and this approach can provide breathing room to make decisions around things like gifting and general legacy planning. Where an IHT liability is expected to persist following gifts etc., we also look at whole of life policies that provide cover with no end-date, making them especially suitable for protecting against the impact of inheritance tax.
We are here to help
If you have any questions regarding lifetime gifting and trusts, or would like to discuss tax planning further, please get in touch with a member of our specialist tax team or contact your usual Azets advisor. Our sister company, Azets Wealth Management, is also on hand to support with safeguarding your family’s finances. Find out more here.
Information correct at time of publishing, but may be subject to change in future. This article is for general information only and is not intended to be advice to any specific person. You are recommended to seek professional advice before taking or refraining from taking action on the basis of the contents of this article.
Azets Wealth Management is a trading name of Azets Wealth Management Limited, which is authorised and regulated by the Financial Conduct Authority. Registered Office: Bulman House, Regent Centre, Gosforth, Newcastle upon Tyne, NE3 3LS. Company Number 05674020. Incorporated in England. Azets Wealth Management Limited is a subsidiary of Azets Holdings Limited