5 tax hacks: how to make financial gifts without a big tax bill

With Christmas fast approaching, giving financial gifts now - or at any time of the year for that matter - could be a great way to save tax while helping your loved ones get on in life.

Every year, parents across the UK give £17 billion in loans and gifts to their adult children, according to data from the Institute of Fiscal Studies.¹ And the FT estimates² that older generations will pass a bumper £7 trillion to younger generations over the next 30 years.

Giving lifetime gifts can be a smart way to reduce your Inheritance Tax (IHT) bill, but gift-givers need to take care. There are plenty of tax traps that could land you with an unexpected bill.

What's more, Budget changes mean more financial gifts could be caught in HMRC’s tax net in the future as the scope of Inheritance Tax increases. So, what are the best ways to pass on wealth while minimising your family’s IHT bill?

Here, we reveal why lifetime gifts are so valuable and the five golden rules for making tax-efficient financial gifts. Navigating these rules will help you and your family keep more of your hard-earned wealth.

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Why make lifetime gifts?

Whether you’re helping out with a home purchase or uni costs, giving financial gifts is a simple way to support your family while also saving IHT in the future.

Making lifetime gifts is one of the easiest ways to reduce the value of your estate so more of it falls within the tax-free IHT allowances.

• Learn more about passing on your wealth

And Budget tax reforms will make gifting even more valuable in the future as more of us face paying IHT. From April 2027, the government³ predicts around 49,000 more estates will end up paying IHT as the tax net widens to include inherited pensions.

• IHT on pensions to push wealthy families into 80% plus tax 

Currently, the IHT rules let you leave up to £325,000 tax-free when you die, with an additional £175,000 allowance if you leave your home to your kids or grandkids. Married couples can potentially leave up to £1 million tax-free as they can transfer unused allowances.

However, anything over these allowances could be hit with 40% tax, which is where lifetime gifting comes in. Giving money during your lifetime could reduce your IHT bill and help you leave more to your family - it’s a win-win.

But understanding the rules is crucial here because there are various knotty traps that could mean your gift is still caught with a tax charge.

Thankfully, there are some clever tax-planning hacks to help you give financial gifts while avoiding a tax bill down the line.

1. Use the annual IHT exemptions to make gifts

One of the simplest ways to reduce your IHT bill is to use annual exemptions to make regular small gifts.

These exemptions are valuable because there’s a hidden tax trap - lifetime gifts can still be hit with IHT if you die within seven years of making a gift.

The good news is that if you use the annual exemptions, the gift won’t be counted towards your estate even if you die within seven years.

Here’s how much you can give away each year, with no risk of a future IHT bill on the gifts:

• Annual exemption - you can give away up to £3,000 each tax year in total.
• Gifts for weddings and civil partnerships - you can give extra gifts when someone gets married—£5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else.
• Small gifts exemption - you can gift £250 each year to as many people as you like, as long as you haven’t used another allowance on the same person.

A couple maxing out their exemptions could potentially give £42,000 every seven years and a further £5,000 if their child got married. This means they could save up to £18,800 in IHT.

These exemptions might seem small, but they can really add up over time, especially if you’re a couple and both use your allowances every year.

2. Understand the “secret” surplus income rule

Another little-known and powerful tax hack is the so-called “gifts from surplus income” exemption. Understanding the fiddly rules here is worth it because the tax savings are potentially sizeable.

Amazingly, according to a Telegraph freedom of information request,⁴ this savvy tax hack was only used by 430 people in 2022.

The good news is that there’s no set cap here on how much you can give. Instead, the limit depends on how much unspent income you have each year.

Again, using this rule will mean your loved ones avoid IHT, even if you die within seven years.

The following rules apply to using this exemption:

• The gifts must be made out of your income.
• There must be a regular pattern of giving, with gifts being part of your “normal expenditure.”
• Making these gifts must not affect your standard of living.

Here, your Excel skills could come in handy because you’ll need to keep records to prove that the income was surplus to your needs.

The record-keeping needed here is well worth it, as the tax savings could be huge. A couple each giving £5,000 every year for 7 years could potentially give gifts totaling £70,000 and save £28,000 in IHT.

3. Don't forget Capital Gains Tax (CGT)

Not understanding the CGT rules could also expose you to another nasty tax trap when it comes to giving gifts.

It’s an issue because many people don’t realise that gifts can trigger CGT. HMRC treats them like selling assets, using the market value to calculate any gain and the tax owed. This can result in a surprising and unwelcome tax bill.

This tax trap can catch families off guard when making lifetime gifts, potentially leading to a tax liability even though the asset hasn’t been sold. For example, if you give your daughter a share portfolio that’s risen in value by £100,000, you could owe CGT of up to £23,280, depending on your other income.

The rule is particularly harsh for unmarried couples who fall outside the spouse exemption for CGT. When they pass assets between themselves, they could unwittingly trigger a tax bill.

If you think this tax trap might affect you, then it’s worth getting financial advice. One option might be to give smaller gifts over time to mitigate a large CGT bill.

• Learn more about Capital Gains Tax

4. Consider getting married

This next tax hack isn’t for everyone, but it’s worth knowing if you’re considering tying the knot.

Our tax system is hugely favourable towards married couples and civil partners, especially when it comes to CGT and IHT - they can pass assets between themselves with no CGT or IHT to pay.

In contrast, unmarried couples could trigger a CGT or IHT bill when they give gifts to each other or pass on wealth in their estate. This painful tax trap could leave some unmarried partners much poorer when their partner dies, with a big tax bill to pay.

The Budget changes, which introduce IHT on pensions from April 2027, could also hit unmarried couples with more tax. Bereaved partners could end up paying IHT on an inherited pension with less to live on in retirement.

By comparison, married couples can inherit assets with no IHT to pay.

5. Think about getting advice

With more of us paying inheritance tax in the future, you might want to think about getting advice. Our financial advisers can guide you but getting specialist tax advice could be money well spent. If you use one of Fidelity’s financial advisers, they can give you the number of a company we use. But it’s important that you do your research and choose someone who is right for you, as the rules are complex. And if your will doesn't consider tax planning, you could end up paying more tax than you need to.

Like Christmas traditions, the tax rules have evolved over many years. Understanding and using them wisely could help you save tax and pass on more of your wealth to the next generation.

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• If you’ve got over £250k to invest (including your pension) you automatically qualify for our Wealth Management servce. Learn about Wealth Management.

Source:

¹ Institute of Financial Studies, February 2023
² FT Adviser, 16 August 2024
³ Gov.uk, 30 October 2024
⁴ Daily Telegraph, 10 August 2024

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Eligibility to invest in a SIPP or ISA and tax treatment depends on personal circumstances and all tax rules may change in the future. Withdrawals from a SIPP will not normally be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.