One of the most common and effective ways an individual can reduce the value of their taxable estate is through making lifetime gifts, such as Potentially Exempt Transfers (“PETs”).
What is a PET?
A PET arises when an individual makes a gift to another individual or bare trust outright, without retaining any benefit from the gift. This could include cash gifts, transfers of property, or other valuable assets.
The gift is considered “potentially exempt” because no IHT is payable at the time the gift is made. However, the exemption only becomes fully effective if the donor survives for seven years after making the gift.
If the donor survives the seven-year period, the value of the gift typically falls outside of their estate for IHT purposes entirely.
The Seven-Year Rule
If the donor dies within seven years of making the gift, the PET ‘fails’ and becomes a ‘chargeable transfer’, and value of this is included in the estate and chargeable to IHT.
If the value of total chargable transfers in an estate exceeds the available nil-rate band (currently £325,000), the tax position depends on when the gift was made before death:
- Within 3 years: full IHT rate may apply
- Between 3 and 7 years: taper relief may reduce the tax payable
It is important to note that taper relief only reduces the tax on the gift, not the value of the gift itself.
Common Exemptions
Certain lifetime gifts can be immediately exempt from IHT, including:
- Any gift that falls within the annual gift allowance of £3,000 per tax year (unused allowance from the previous tax year can be carried forward)
- Small gifts of up to £250 per recipient
- Gifts on marriage or civil partnership (subject to limits)
- Regular gifts made out of surplus income (provided certain requirements are met and extensive records and accounts are maintained)
Although lifetime gifting can be tax efficient, careful planning is essential. Donors should consider:
- Retaining sufficient assets for their own future needs
- Seeking advice regarding the Capital Gains Tax implications of any gifts
- Keeping detailed records of gifts including dates, values and recipients
- Avoiding making “gifts with reservation of benefit”, which may apply where the donor continues to benefit from the gifted asset.
The rules surrounding PETs and IHT can be complex, with several rules, requirements and limitations to consider. Professional advice should always be sought to ensure gifts are structured effectively and do not produce unintended tax consequences.