Inheritance Tax Shake-Up Puts Pensions in Firing Line but Little-Used Gifting Exemption Could Save Thousands
Thousands of pounds in inheritance tax could be saved if more people took advantage of a little-known exemption that allows surplus income – from pension, salary, rental income or dividends – to be gifted tax free.
Changes coming into force in April 2027 which close the inheritance tax exemption on unused pensions mean pensioners are no longer incentivised to maintain such large pension pots. Many are drawing down more cash and if they don’t need that money to fund their lifestyle, regular gifting from this excess income can be a tax efficient way of passing money to children and other family members.
As well as presenting an opportunity to individuals who bring in more money than they need, those going through the probate process can also save on tax bills if they can prove past gifts from the deceased’s estate fall under the exemption.
Hodge Jones & Allen wills & probate partner Nicola Waldman says: “Later in life it’s not uncommon for people to have extra income that they don’t really need to fund their lifestyle. Many will be drawing down more from pensions than in the past in response to the inheritance tax exemption for pensions disappearing next year, subject to income tax considerations. Some will have paid off their mortgage, have an income from rental properties or a healthy investment portfolio to fall back on.
“Few realise that if they have more money coming in than they need day to day, gifting that money to their children or other family members on a regular basis could potentially save them a great deal on their inheritance tax bill.”
Inheritance tax must be paid on any gifts received in the seven years prior to a person’s death over the £3,000 annual limit. This rule does not apply to gifts paid out of excess income provided:
- The gift is part of your normal expenditure. It needs to be part of a pattern of regular giving and an ongoing commitment with monthly or annual transfers that those receiving can provide evidence for.
- The gift comes from post-tax income not capital. This could be from a salary, a pension, rental income, dividends or interest.
- The person gifting the money must still be able to maintain their lifestyle and meet their living expenses without digging into savings or investments.
As well as being an important consideration for those looking to reduce the inheritance tax bill on their own estate in the future, family members going through the probate process can also benefit through retrospective use of the exemption, even if it is not something their deceased relative had planned for.
Nicola explains: “Where family members have been gifted money by the deceased on a regular basis, it is still possible to make use of the exemption as long as you have the evidence needed to prove the gifts fall within the rules.
“This will mean providing details of expenditure and income during the years the gifts were given, demonstrating the total amount gifted did not exceed the excess money coming in.”
Anyone looking to take advantage of this tax exemption should start early to establish a pattern of gifting and keep good records of what has been gifted, ensuring loved ones will have access to these records in the event of their death. Any regular gifting should be reviewed to ensure that the gifts continue to fall within the exemption even when circumstances change.