The annual gift exemption allows individuals to give away up to £3,000 each tax year without those gifts being counted towards their estate for IHT purposes. However, successive Governments have chosen not to increase the allowance in line with inflation. As a result, while the exemption remains useful, its real value has steadily declined.
If the allowance had kept pace with inflation since 1981, it would now be worth around £13,600. When the exemption was introduced, £3,000 represented around 16% of the average UK house price. Today it equates to little more than 1%, illustrating just how much its purchasing power has fallen.
This is an example of what is often referred to as fiscal drag. When tax allowances remain frozen while prices continue to rise, their real value gradually falls, meaning taxpayers receive less benefit from them over time.
In practical terms, this means the annual exemption no longer allows families to pass on the same level of wealth as tax efficiently as it did when it was introduced. While £3,000 can still make a valuable contribution towards IHT planning, it now plays a much smaller role than when the exemption was introduced.
What families can do
Fortunately, the £3,000 annual exemption is only one of several IHT gifting exemptions available. Even though its value has been eroded by inflation, there are still effective ways to pass on wealth during your lifetime and reduce a future IHT bill.
Lifetime gifts
Many gifts made during your lifetime will fall outside your estate for IHT purposes if you survive for seven years after making them.
If you die within seven years of making the gift, it may be liable for IHT, depending on the circumstances. In some cases, taper relief can reduce the amount of tax payable on larger gifts. For example, where taper relief applies, the effective IHT rate reduces from 40% to 8% on gifts made between six and seven years before death, while those made between three and four years before death pay 32%.
Lifetime gifting can offer a significant opportunity to reduce IHT, but it is one that many people fail to make full use of.
Gifts ‘out of surplus income’
Unlike most lifetime gifts, gifts made ‘out of surplus income’ do not require you to survive for seven years in order to qualify for exemption from IHT. This makes them particularly valuable for older people or those with serious illnesses.
To qualify, the gifts must come from unused salary, pension or dividends and not from assets like savings or shares. They must also not affect the donor’s standard of living, for example by forcing them to dip into savings to cover everyday expenses after making the gift.
There is no limit on the amount that can be given under this exemption. However, professional advice is recommended, as detailed record keeping is essential if the exemption is to be claimed successfully.
The importance of planning ahead
Although the £3,000 annual exemption has lost much of its value over time, it remains one of several valuable IHT exemptions available. Used alongside other gifting strategies, it can still help reduce the value of an estate over time.
As IHT thresholds remain frozen, more estates are likely to fall within the scope of IHT.
Executors may also need to account for gifts made in the seven years before death, so keeping accurate records throughout your lifetime can make the administration of your estate much simpler and reduce the likelihood of HMRC raising queries.
Planning ahead, reviewing your gifting strategy and understanding available exemptions can help minimise IHT and reduce the risk of complications for your family later on.
How TWM can help
Whether you’re planning regular gifts to family members or reviewing your wider estate planning arrangements, our Private Client team can help you make full use of available allowances and minimise unnecessary tax exposure.
We can advise on structuring gifts, maintaining appropriate records, and developing an estate planning strategy tailored to your circumstances. Where HMRC raises queries, we can also guide you through the process and help protect the estate.
To discuss your circumstances, please contact our Private Client team for an initial, no-obligation consultation.