The inheritance tax (IHT) annual exemption is often overlooked. This is probably because the exempt amount is a relatively modest £3,000 (for 2025/26). However, as the well-known slogan from the popular supermarket goes, ‘every little helps’! For example, £3,000 given away in every tax year for seven years can shelter £21,000 from a possible IHT liability of £8,400 on death; for a married couple (or civil partners), the potential IHT saving doubles to £16,800, for very little effort or planning.
Give…Give…Give!
Any unused annual exemption can be carried forward to the following year, but not beyond (IHTA 1984, s 19). The annual exemption for the later year must be used completely before any used amount from the previous year; and if any amount brought forward is left unused, it is lost.
Note that in 2025/26, Charlotte cannot claim brought forward annual exemption of £1,500; the £1,000 carried forward from 2023/24 was unused and is therefore lost. The annual exemption applies to lifetime gifts only (i.e., not to an individual’s estate on death). It can be used for larger gifts; so, on a gift of (say) £10,000 the first £3,000 is exempt, leaving £7,000 within the scope of IHT (unless other exemptions are also available).
Example: Too late!
Charlotte made lifetime gifts as follows:
|
Tax year |
Gift £ | Exemption available £ | Carried forward £ |
|
2023/24 |
2,000 |
3,000 |
1,000 |
|
2024/25 |
2,500 |
4,000 |
500 |
| 2025/26 | 5,000 | 3,500 |
Nil |
PETs and the Annual Exemption
Most types of lifetime gifts (e.g., from one individual to another) are potentially exempt transfers (PETs). A PET made at least seven years before death becomes an exempt transfer. Conversely, a PET becomes a chargeable transfer for IHT purposes if made within seven years of death. The annual exemption is set against any immediately chargeable gift (e.g., into a discretionary trust) and not against any PET made earlier in the same tax year. If the donor dies within seven years (i.e., the PET becomes chargeable), for annual exemption purposes it is treated as having been made later than the immediately chargeable gift; in other words, the immediately chargeable gift keeps the annual exemption. HMRC’s guidance (in its Inheritance Tax Manual at IHTM14143) states (rather confusingly): ‘If the transferor has made transfers to more than one liable person on different days in the same tax year, then apply the annual exemption to the earliest transfer first. It does not matter whether the transfers are potentially exempt or immediately chargeable.’ For the avoidance of any doubt, chargeable lifetime transfers (CLTs) should therefore be made before PETs in the same tax year, if possible.
CLTs and the Annual Exemption
As indicated, gifts which are PETs may result in the annual exemption being wasted, if the donor survives for at least seven years.
Conversely, CLTs generally ‘capture’ and retain the annual exemption. Gifts into most types of trust are CLTs. Consideration could therefore be given to gifting assets into an appropriate trust. Whilst relatively small gifts into trust are sometimes troublesome because they can affect the IHT rate, additions at or below the annual exempt amount should generally prevent such problems arising.
Practical Tip
If gifts are also made on which the ‘normal expenditure out of income’ exemption is being claimed, make sure that other gifts are made from capital rather than income to ensure that the annual exemption is also available.