What is a “potentially exempt transfer” and how could it affect your family?

You may have read about the current debate surrounding Inheritance Tax (IHT) in the news, after prime minister Rishi Sunak is rumoured to be considering a reduction of the tax.

These proposed cuts may be implemented in light of a continued increase in IHT receipts. FTAdviser reports that 2023 could be a “record year” for HMRC’s IHT takings, as receipts reached £2.6 billion between April and July this year alone.

There are plenty of factors that are contributing to the increase in IHT receipts, including the government’s freezing of key thresholds.

With all this in mind, you could be planning to offer your loved ones a portion of your wealth before you pass away in order to avoid attracting a large IHT liability later. These payments are known as “potentially exempt transfers” (PETs) and, in some cases, could help to mitigate your IHT bill.

Crucially, in light of rising IHT receipts, the Telegraph reports that the number of PETS being made has increased by 48%.

Read on to find out all you need to know about PETs.

Potentially exempt transfers are often used to reduce the value of a person’s estate before they die

Common sense tells us that if you reduce the value of your estate by giving some money away now, your loved ones may then pay less IHT when you pass away.

This is often true, but the reason these transfers are “potentially exempt” is because simply giving away a large sum of money is not always enough to avoid paying IHT on that sum.

So, to understand how PETs work, some IHT basics are required first.

Your family may be liable to pay IHT if your estate is worth more than the “nil-rate bands”, which designate the amount under which no tax is due. Currently frozen until 2028, these are:

· A £325,000 “nil-rate band” covering all assets including property

· An additional “residence nil-rate band” of up to £175,000, which is available for properties passed down to direct descendants (children or grandchildren).

As such, you could potentially pass down up to £500,000 in assets, if a family property is included, without any IHT being due at all. If you and your spouse cleverly combined your allowances, you could potentially leave a tax-free inheritance of up to £1 million.

Any assets surpassing the value of the nil-rate bands are likely to attract IHT. This is where PETs come in.

As of the 2023/24 tax year, everyone has an “annual exemption” of £3,000. This means you can give away up to £3,000 tax-free (or £6,000 in combination with your spouse or civil partner) each year.

However, gifts in excess of your annual exemption are “potentially exempt”, meaning that if you pass away fewer than seven years after they’re given, your family could still owe IHT on the sum.

There are a number of complex rules surrounding the seven-year rule and PETs, which we have explored in more detail on our insights page. But for now, what you need to know is:

· If you transfer more than £3,000 to another person or people in one financial year, the amount in excess of that sum counts as a PET.

· If you were to die fewer than seven years after a PET is made, it may still count as part of your estate, and could be liable for IHT.

As such, if you’re planning to give away assets now to mitigate IHT later, speaking to a professional can help you understand:

· Whether the wealth transfer counts as a PET

· The IHT liability any PETs could accrue in certain circumstances

· The allowances and reliefs available to you and your family.

We’re here to help with all matters concerning wealth transfers, inheritance, and tax.

Giving while living can help support your family throughout your life, not just when you pass away

On a more positive note, giving some wealth to your loved ones before you pass away can be greatly rewarding for everyone involved.

Offering a gradual stream of wealth to the next generation as they grow up could help them to:

· Buy their first home

· Climb the career ladder without worrying about their finances

· Pursue further education opportunities

· Pay for the wedding and honeymoon of their dreams

· Put funds away for their own children.

If you decide to remain prudent and keep your financial gifts within the limits of the £3,000 annual exemption, over time this money could provide a significant boost to your loved ones’ income.

For instance, if you had two children and decided to offer them each £1,500 a year from now on, in 10 years’ time they’d each be £15,000 better off. This sum could go a long way in helping them to fund big life milestones, or simply to supplement their income and reduce financial stress.

And, provided that the annual exemption remains at £3,000, you’d be reducing the value of your estate tax-efficiently, leaving less to attract an IHT bill later.

Get in touch

However you decide to distribute your wealth, your Kellands financial planner can offer invaluable support. We specialise in helping our clients to protect their families’ wealth from unnecessary tax and other often-overlooked vulnerabilities.

To learn more about PETs, giving while living, or any other inheritance matter, email us at hale@kelland.co.uk, or call 0161 929 8838.

Please note

All contents are based on our understanding of HMRC legislation, which is subject to change.

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.

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