Gifting with intent: How to avoid costly surprises

Michelle Holgate
Director, Wealth Manager
RBC Brewin Dolphin

Stringent tax changes introduced in the last two Autumn Budgets make it more important than ever for families to start planning the passing of wealth and property to the next generation.

Under current tax rules, retirees can pass on unspent pension pots without their descendants incurring inheritance tax (IHT). This changes in April 2027 when unused pension pots will fall into the IHT net. As a result, many pension investors are grappling with whether to convert their tax-free lump sum into a cash gift now, to reduce the potential IHT charges on their estate when they die.

In addition, the chancellor will implement changes to agricultural property relief (APR) and business property relief (BPR) in April 2026. These limit the 100% tax relief on qualifying agricultural and business assets (including most farmland, property and business assets) to the first £2.5m of the combined value (if unused this allowance can be transferred to a surviving spouse, producing a limit of £5m). Qualifying property and assets above that value will benefit from 50% relief, producing an effective IHT rate of 20%.

Gifting to the next generation

One way to mitigate IHT bills is making a Potentially Exempt Transfer (PET), a gift of unlimited value which is potentially free of IHT provided the donor survives a further seven years.

“Strategic gifting was once seen as a tactic of the super affluent, but has now gone mainstream,” says Michelle Holgate, Wealth Manager at RBC Brewin Dolphin. “We’re seeing enquiries, particularly from farmers, looking to pass on assets such as land to the next generation without triggering a big IHT bill.

“People are naturally protective of family businesses which in some cases have been built up over several generations. They want to keep these businesses in the family and see them thrive long into the future.”

However, a Freedom of Information (FOI) request made by RBC Brewin Dolphin revealed that in the 2022-23 tax year, 14,030 PETs incurred IHT because the donor died within seven years of making their gift.

The tax rate reduces the longer a donor survives, but if they die in the first three years after making a gift, the recipient must pay the full 40% normally charged for IHT. The HMRC information revealed that the top 25 “failed gifts” in the 2022-23 tax year averaged £7,930,000 in value after allowances and exemptions, which could trigger an eye-watering tax bill of up to £3,172,000. Even the average “failed gift” of £171,000 after allowances and exemptions could result in a recipient facing a tax bill of £68,400.

Holgate says: “Gifting when you’re alive is an integral part of estate planning and can help mitigate exposure to inheritance tax later on, but it’s important to understand the rules and have the right counsel. For the gift to be tax exempt, the giver must survive the event by seven years. If the donor dies within the seven years, then inheritance tax on the amount in excess of the available nil rate band, is payable by the recipient on a sliding scale of 40% to 8%, depending on how much time has passed between the gift being made and the donor dying.

“This news can come as a massive shock to people who are already mourning the loss of a loved one. That’s why we would urge clients to plan well ahead of time or consider insurance policies which meet these bills.”

Inheritance tax on gifts above £325,000

Years between gift and death	Chargeable amount	Effective rate of inheritance tax
Less than 3 years	100%	40%
3 to 4 years	80%	32%
4 to 5 years	60%	24%
5 to 6 years	40%	16%
6 to 7 years	20%	8%
7+ years	0%	0%

IHT bills double

Inheritance tax revenue is predicted to almost double over the next five years to £14.3bn, according to the Office for Budget Responsibility (OBR).

IHT is currently charged at 40% for estates worth more than £325,000, with an extra £175,000 allowance towards a main residence if it’s passed to direct descendants.

Married couples or civil partnerships can share their allowance, meaning they can pass on up to £1 million to their children without any tax. Co-habiting couples do not benefit from transferable allowances.

Ways to manage IHT

Use a trust

Considering long-term family wealth planning alongside making gifts into trust can mitigate the impact of surprise IHT bills triggered by the seven-year rule.

Trusts can be attractive as they allow donors to give away assets indirectly, meaning the assets might no longer count towards their IHT bill when they die – although in most cases you still have to live for seven years after transferring assets into the trust for this to work.

Typically, a trust is held and managed by a third party known as a trustee. Often, grandparents will set aside money for grandchildren with the parents as trustees. Money is usually released when the grandchildren are mature enough to make prudent financial decisions, say at age 18 or 21, although this may be at the discretion of the trustees.

Holgate says: “While trusts can be used to ringfence funds in a way that’s tax efficient for inheritance, it’s important to consider which type of trust to use. One type may give the child the absolute entitlement to the money while another may offer the trustees greater flexibility and discretion, even making allowances for children who have not been born yet.”

Gift insurance

Another option worth considering is gift inter vivos insurance policies, which pay out if the donor doesn’t survive the seven years and a tax demand lands on your doorstep.

Holgate says: “Long-term wealth planning that considers both your own cashflow needs and your desire to pass down wealth can help to ensure your loved ones aren’t hit with an unnecessary bill. However, there will inevitably be occasions when this can’t be avoided and that’s when a gift inter vivos policy might come in – an insurance policy used to cover the inheritance tax liability that can arise when a person makes a gift whilst they are alive but dies within seven years.

“As you’d expect, these policies have a seven-year term and should be placed in a trust, otherwise the benefits from a claim on the policy may be added to the individual’s estate, thereby increasing the tax liability.” 

Sooner the better

The changes to taxation and the ways you can manage their impact on you and your family are complicated, but with deadlines looming in April and 2027, it’s important to get to grips with them as soon as possible.

Holgate said: “With so much to consider, it makes sense to have expert advice every step of the way. As the HMRC numbers for families caught out by the seven-year rule show, the sooner you sit down with your wealth manager the better if you want to plan your gifting in the most tax efficient manner.”

About the author

Michelle Holgate

Director, Wealth Manager

Michelle has 20 years’ experience specialising in providing financial advice on IHT planning, pensions, investments, and trusts to high-net-worth clients across the UK.

---

The value of investments, and any income from them, can fall and you may get back less than you invested. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. You should always check the tax implications with an accountant or tax specialist. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Information is provided only as an example and is not a recommendation to pursue a particular strategy.