Seven gifting mistakes that could cost your loved ones

The government is collecting more in death taxes than ever before, and the inheritance tax (IHT) take has more than doubled in a decade thanks to rising asset values and frozen allowances. This, together with the April 2027 changes that will bring unused pensions into the value of estates, has led to many more people considering using gifts to reduce the value of their estates for tax purposes.

The taxman refers to gifts as ‘transfers of value’, meaning it could be anything from giving away cold hard cash to the value of investments, fine art or property. A gift can also be the amount you lose where you sell or transfer the ownership of something for less than it’s worth on the open market.

While some gifts are exempt from inheritance tax (IHT) completely, including those made between spouses and civil partners, there are allowances for other types of gifts, and a whole host of record keeping requirements to make sure adequate evidence is kept.

It’s an area where financial advice is invaluable, and paying an adviser could help you avoid costly mistakes. Get the rules wrong, and you run the risk of leaving your loved ones with less than you’d hoped for, as the gift is still part of your estate. On the flip side, you could be tempted to give away too much, leaving yourself short and without enough to live on in later life.  

Assuming you’re in a comfortable position and can afford to give money away, here are seven mistakes to watch out for.

1. Not making the most of your annual gifting allowances

There are gifts you can give every tax year that are exempt from IHT and reduce the value of your estate.

The ‘annual exemption’ lets you give away a total of £3,000 each year, either to one person or split between several others. You can also bring forward any unused annual exemption for one year, doubling the total to £6,000. Unlimited ‘small’ gifts of up to £250 per person can also be made, if you haven’t already used your annual exemption on the same person.

2. Giving away property you continue to benefit from

It might be tempting to give away a high-value asset, such as your home, with the aim of getting it outside of your estate for IHT. But gifting isn’t simply signing over a house into someone else’s name. Transferring ownership of an asset but still getting some benefit from it or retaining control will fall foul of the ‘gift with reservation of benefit’ rules and mean it is swept right back into your estate for IHT.

For a transfer to be a true gift, the person making the gift (the donor) must not be able to benefit from it. With your home, this would mean entering into the same agreement and relationship as a landlord and tenant. That is, a formal agreement to pay a fair market rent for any property you continue to live in, and for the rent and terms to be reviewed as you’d ordinarily expect on the open market.  

While the rule is often associated with giving away a property, it can catch other types of assets too. Other examples include giving away a piece of artwork and still hanging it on your own wall or giving away a holiday home but still expecting to spend your trips there. Transferring the ownership of shares in a company but retaining rights associated with those shares, such as voting rights or an option to buy back shares if certain conditions are met, would also be gifts of reservation, even if an option was not exercised.

3. Misunderstanding the seven-year rule

Potentially exempt transfers usually fall outside of your estate for IHT once seven whole years have passed. For gifts that were made over three years but less than seven years before death, taper relief might be available to reduce the IHT bill.

But people often believe taper relief applies to all gifts, or that the relief reduces the value of the gift. In fact, taper relief only applies where the total value of gifts made in the seven years before death exceeds your nil rate band, and only on the tax due on the portion above that band.

Using the example of Sarah, who makes a gift of £400,000 to her niece and survives for just over six years. Her estate is worth £1 million in total, and she has a nil rate band of £325,000 available. On the face of it, she has a full nil rate band to use against her estate, and she could benefit from taper relief and a lower 8% rate of IHT on the £400,000 gift.

But in practice, the value of the gift uses up all her nil rate band first, with the £75,000 above this subject to IHT. Taper relief reduces the rate of IHT on the £75,000 taxable amount to 8%, but as her nil rate band has already been used up, the remaining £600,000 estate is subject to IHT at 40%, bringing the total tax bill to £246,000.

4. Making a wedding gift after the big day

Special rules for gifts made in anticipation of marriage or forming a civil partnership mean up to £5,000 can be gifted to a child, £2,500 to a grandchild or great-grandchild, or £1,000 to anyone else. These can be combined with other allowances, including the annual exemption, but to meet the rules, a wedding gift must be made before the wedding itself, and the wedding must go ahead.

Anything over the wedding limit or made after the marriage itself will become a potentially exempt transfer. But combining the rules could mean up to £24,000 can be given between two parents to their child and their soon to be spouse.

5. Overlooking gifts from surplus income

You can make unlimited gifts from income that will be free of IHT, provided you can show they form part of your regular expenditure and that they don’t reduce your standard of living. Income here includes earnings, pension income, investment income and interest from savings, but not proceeds from selling investments for cash.

Increasing pension withdrawals could result in a higher income tax bill, or even move you up an income tax bracket, depending on your other income at the time. But if you choose to gift money to family members to make their own pension contributions, they could then receive pension tax relief on that money, while the gifted amount falls outside your estate for IHT purposes. If they have available annual allowance and qualify for UK tax relief, the relief they receive could help offset the tax paid when the money left your pension.

The tax rules put the onus on the person making the gift to prove it meets the conditions, but your personal representatives will be administering your estate and completing any IHT paperwork once you’re gone. You can help by keeping evidence of your income, showing that you’re not having to cut back on your normal spending to make the gifts, and making sure they know where to find those records. Getting hold of bank statements and other records can be difficult without probate, and IHT usually needs to be settled before probate is granted. It might seem onerous, but the value of the IHT exemption certainly makes it worth it.

6. Not writing life cover in trust

If you’re planning to make large gifts, life insurance can be a simple way to fund a potential IHT bill if you don’t survive for the full seven years before they fall out of your estate. But payouts, including from any cover you have through your employer, can also count as part of your estate unless your policy is written in trust.

Writing policies in trust removes the payout from your estate and protects the IHT status of the gift you’ve made. As IHT must normally be paid within six months to avoid interest and needs to be settled before probate is granted, insurance could make things easier for your loved ones and prevent assets having to be sold to help pay any bill.

7. Misunderstanding charity legacy gifting rules

A reduced 36% rate of IHT is available if at least 10% of your ‘net estate’ is left to charity. But unless a will is properly drafted, your estate might not qualify for the reduced rate, meaning more money for the taxman, potentially at the expense of your beneficiaries.

The 10% test is not applied to the whole estate; it is tested against what’s known as the ‘baseline amount’. In simple terms, this is the total value after any reliefs, debts, funeral expenses and the standard nil rate band. A common mistake is to also deduct any residence nil rate band here, which incorrectly shrinks the baseline amount and makes it appear as if the required charity legacy is smaller.

The pension changes from 6 April 2027 also mean that anyone with a 10% charitable legacy in their will should review it, alongside their pension nominations and their wider estate planning. The changes will bring unused pension pots into the estate for IHT purposes, but who a pension is left to remains outside the scope of a will.