Inheritance Tax and Exempt Transfers

For inheritance tax (IHT) purposes, gifts fall into one of three categories: exempt transfers, potentially exempt transfers (PETs), and chargeable lifetime transfers (CLTs). In this article, we focus on the first category – exempt transfers. This article is particularly relevant to the CII R03 and AF1 exams but may also be useful for those studying R01, R05, R06, and AF5.

Exempt transfers

Exempt transfers can be further subdivided into those that apply only when a gift is made during a person’s lifetime and those that are effective whether the gift is made during a person’s lifetime or on their subsequent death.

These gifts do not have to be included in a person’s estate when establishing the amount on which IHT is due and are therefore wholly effective for IHT purposes, providing any qualifying conditions are met and the gift is made outright and unconditionally. 

Transfers that are only exempt during lifetime

Gifts that are only exempt if they occur during a person’s lifetime include:

• small gifts;
• gifts within the annual exemption;
• gifts out of normal expenditure;
• gifts on wedding and civil partnership ceremonies; and
• gifts for education and maintenance. 

Small gift allowance

The small gift allowance enables an individual to make any number of outright gifts of up to £250 per tax year. Each gift must be to a separate person and the exemption cannot be combined with another exemption for the purposes of making a larger gift.

All of the other lifetime exemptions can be combined to make a larger exempt gift. 

Annual exemption

The annual exemption is worth £3,000 each tax year and, if not used in full or in part, can be carried forward one tax year and used once the annual exemption for that tax year has been fully used. It is, perhaps, the most useful of exemptions for those who cannot afford to give away large sums but can afford to drip-feed assets out of their estate. 

Normal expenditure out of income

For gifting on a regular basis, the normal expenditure exemption can be used. A person can give away an unlimited amount of money providing they can prove that doing so is part of their normal expenditure pattern and that the money itself comes from their income and not their capital. Income includes earned, rental and savings income but not income from a 5% withdrawal from an investment bond as this is, in effect, a return of capital.

This exemption is often used to cover the premiums on a life policy written under a trust that has been taken out to fund either an IHT bill due on an estate on death or on a lifetime gift that was not exempt. This exemption can also be used to make regular contributions into a personal pension, a child trust fund, or a junior ISA for another person such as a grandchild. 

Gifts for weddings or civil partnerships

Up to £5,000 can be given by each parent to a child as a wedding or civil ceremony gift. Grandparents can gift up to £2,500 as can each party to the wedding or civil partnership to each other. Anyone else can give up to £1,000. The gift can be made in the run-up to the ceremony or on the day itself. 

Other exempt lifetime gifts

Finally, certain payments for the education, training, or maintenance of children under the age of 18 or in full-time education are also exempt. 

Transfers that are exempt during lifetime or on death

Gifts that are exempt whether they occur during a person’s lifetime or on their death include:

• gifts between spouses and civil partners;
• gifts to charities; and
• gifts to political parties. 

Spouses and civil partners

There is no limit on gifts between UK-domiciled spouses or civil partners.

However, where assets pass to a partner who is non-UK domiciled, the limit is £325,000 unless they elect to be treated as if they are UK-domiciled. This is in addition to the £325,000 nil rate band. Note that if they make this election their entire estate, both in the UK and overseas, will be brought into the UK’s IHT net. 

Other exempt gifts that are exempt during lifetime or on death

Gifts to charities, to major political parties, or for the national benefit are exempt with no limit.

Where an individual dies as a result of active service, and this now includes emergency services staff responding to emergency situations, their entire estate is free from IHT.

Grab the resources you need!

If you’re studying for your CII R03 exam, and you’re aiming for a comfortable pass, you need to get all the practice you can. Grab our free taster to try out one of Brand Financial Training’s resources for yourself.  Click the link to download the R03 calculation workbook taster now!

Alternatively, you can try the taster for AF1 if you’re studying for that exam.

Information in this article is correct as at 3 October 2022.