Financial gifts gain popularity this Christmas as inheritance tax rules could tighten

It’s gift giving season, which means many families will be working through a long wish list of gaming consoles, sports equipment, dolls, action figures and more. But with the recent proposed changes to inheritance tax (IHT), financial gifts are also gaining popularity.

While the latest toy will probably be broken or re-gifted by this time next year, financial gifts have the potential to keep on giving for many years to come. Here, we’re looking at why the new IHT rules are making financial gifts a bigger consideration this Christmas, and how to make them effectively.

Gifting priority rises under new IHT rules

As Ian Dyall, head of estate planning at Bestinvest’s parent company Evelyn Partners, says, financial gifting during your lifetime and not just on death is increasingly attractive for older savers. “Helping loved ones achieve greater financial security brings joy and satisfaction,” he explains. “As living costs rise and demands grow on younger generations, gifting wealth has become a priority for many families.”

This year’s trend is being driven by the UK’s recent Autumn Budget changes. From April 2027, defined contribution pension pots may be included in estates’ IHT liabilities. This is a major shift for many retirees, who often purposefully left excess pension assets untouched to take advantage of the previous IHT exemption.

Before we go any further, it’s important to note that these IHT changes haven’t yet been passed into law, and so they are subject to change. There is a risk in taking action before the proposed changes come into force, should the end legislation differ from those proposals.

If the changes do go ahead as planned, they could have a significant impact for many. For example, for someone above the IHT threshold and with a pension balance of £300,000, this could result in an IHT tax bill of £120,000.  

The freeze on IHT nil-rate band threshold of £325,000 (and the main residence threshold of £175,000) has also been extended to 2030, meaning more estates will become liable as inflation and investment returns grow asset values. The Office for Budget Responsibility projects that by the 2027/28 tax year, an additional 10,500 estates will face IHT due to the inclusion of pension assets, with an average additional tax bill of £34,000.

Gifting rules explained

The potential financial benefits of gifting are clear. Without a plan, your beneficiaries may face significant tax burdens, including a potential combined rate of up to 67% when inherited pension pots are taxed both under IHT and income tax rules.

Dyall says, “For families with substantial estates, lifetime gifting can save beneficiaries a 40% charge on taxable assets. However, it’s crucial to ensure that these gifts comply with IHT rules and that donors retain enough for their own needs, including unexpected costs like care fees.”

There are many complex rules to consider when it comes to gifting during your lifetime. Here are some of the fundamentals that you should be aware of if you have a potential IHT liability:

Annual exemptions

Gifts made within your annual gift allowance fall immediately outside of your estate for IHT purposes. Individuals can gift up to £3,000 annually, or £6,000 if unused allowances from the previous tax year are carried forward. Additional smaller gifts of up to £250 per person are also allowed.

That leaves plenty of scope for generous gifting at Christmas time, with the added bonus of an immediate reduction in the estate value for IHT.

Regular gifting from income

Gifts made as part of normal expenditure from excess income can be exempt from IHT if they don’t affect your standard of living. In theory, there is no limit on these gifts, as long as it is genuine excess income.

For example, grandparents might have income from the state pension that they don’t need, because their lifestyle can be fully funded by income they receive from workplace pension schemes.

Larger gifts and the seven-year rule

Gifts exceeding the annual exemptions can be made but remain part of your estate for seven years. If you survive this period, the gift becomes fully exempt. These are known as potentially exempt transfers (PETs).

The seven-year rule operates on a sliding scale known as taper relief, with a proportion of the gift that is outside the estate for IHT purposes increasing from year three onwards.

Trusts

Trusts provide a structured way to gift while retaining some control. Discretionary trusts protect assets from misuse or loss, while bare trusts offer flexibility, particularly for minor beneficiaries.

Care needs to be taken on large gifts into trust above the IHT nil rate band as this could be classed as a chargeable lifetime transfer (CLT) and attract an immediate tax charge.

Your pensions gifting strategy

Previously, pensions could arguably be ignored when it came to planning for IHT. That’s not the case anymore, meaning retirees will need to consider the most effective way to tread the line between IHT and other taxes like income tax.

Here are a couple of examples of the opportunities for tax-efficient gifting strategies with a pension for those who have reached the retirement age of 55.

Tax-free lump sums

You could withdraw your 25% tax-free pension allowance and gift it, starting the seven-year clock to IHT exemption. Of course, you will have to weigh up the opportunity cost of this, as it may mean you need to use other, taxable assets for your own expenses.

Regular pension withdrawals

As mentioned previously, excess income that is not required to meet your own living costs can be gifted without triggering the seven-year rule. Setting up an income stream from a pension could provide the ability to utilise this rule.

You should take into account all taxes for these strategies, not just IHT. Dyall says, “Don’t be too blinded by IHT as most donors will be paying tax on pension withdrawals. Could you be paying a higher rate of income tax by increasing pension withdrawals for gifting, which could wipe out any eventual IHT saving? This is obviously a danger if the pension withdrawals are subject to the higher 40% or 45% marginal rates of income tax.”

Plan ahead for effective gifting

While gifting offers significant advantages, careful planning is a must. Larger gifts may trigger taper relief if the donor doesn’t survive seven years, reducing the IHT rate over time but potentially leaving beneficiaries with unexpected tax bills.

Dyall advises, “The earlier you gift, the more chance it has of being exempt. But it’s important to seek professional advice to balance tax efficiency with ensuring your own financial security.”

If the IHT rules do tighen, financial gifts could become a meaningful way for families to share wealth this holiday season or in the future while reducing future tax burdens.

This article is not a recommendation to take or refrain from any course of action.