Families planning to pass on wealth face complex IHT rules – and the cost of getting them wrong is rising
Inheritance tax is collecting more from UK families than ever, and the way wealth is passed between generations is about to become significantly more complicated.
For families using gifting to help younger relatives onto the property ladder, the mechanics matter, and the most common mistakes are proving costly.
New Freedom of Information data obtained by The Private Office from HMRC shows around 15% of estates that included gifts paid inheritance tax on them in 2022/23. But getting the structure of a gift wrong can prove expensive. HMRC has collected an estimated £336 million in inheritance tax over the past five years from failed gifting arrangements, where assets were deemed not to have been fully given away.
What families are getting wrong
Grace Whalley (pictured top), financial adviser at The Private Office, told Mortgage Introducer the most common error she encounters is a gift with reservation of benefit, where a parent transfers an asset but continues to benefit from it.
"It could be that they gift their rental property to their child, but then they still get the rental income from that, so they've retained a beneficial interest," she said. "That's a failed gift."
A second recurring mistake involves the surplus income exemption – a rule that allows regular gifts out of income to be made free of inheritance tax, with no upper limit, provided they do not affect the giver's standard of living. According to HMRC's published inheritance tax statistics, the rules around this exemption are among the most frequently misapplied in estate planning.
"We often see people assuming that they've made gifts out of surplus income when actually they haven't," Whalley said. "The gift out of surplus income rules are quite strict – it has to be a consistent and regular pattern. That's always one that catches people out."
How the seven-year rule actually works
The seven-year rule is a central feature of inheritance tax (IHT) planning in the UK, but Whalley said anxiety about its timeline causes many families to delay gifting, often to their detriment.
Under current rules, a potentially exempt transfer (PET) falls outside the taxable estate if the giver survives for seven years after making the gift. Where the giver dies between three and seven years of making the transfer, taper relief reduces the rate of tax due on a sliding scale.
"The timeline puts people off because a lot of people leave it until they think, 'I'm a bit worried about whether I could actually do seven years,'" Whalley said. "We definitely see that that is problematic."
For those that do face an IHT liability, acting earlier almost always produces a better outcome. "Providing you live for three years, you've done something better than you would have done nothing," Whalley said. "You start getting your taper relief and you're still in a better position if something happened. The sooner you start the better it's going to be, because you naturally have more time."
Why the whole family needs to be in the room
Whalley said tax-efficient gifting from one generation can easily be undone if the recipient has not taken their own financial advice, and that family-wide planning is increasingly critical.
"If you then gift a load of money in a really tax-efficient way to your children only for them to stumble upon a silly tax rule – whether that's they're a higher rate or additional rate taxpayer and they've left it all in cash, and all the interest it's accruing is just taxable anyway – that's a problem," she said. "Or they put it all into a general investment account and there's a big gain, great, but then they get hit with a load of tax on the way out because they didn't plan to put it into pensions and ISAs."
She gave one example of how coordinated planning can generate a double saving. "You might want to take some money out of your pension and gift it to your children. You take the money at 20% tax, gift it to your child, and they're a higher rate taxpayer, so they put it into their pension and they get 40% tax relief. As a family unit, you've just saved 40% inheritance tax and 40% income tax, so that's a double saving."
Rising house prices and frozen IHT thresholds have steadily drawn more households into scope for inheritance tax, prompting clients to ask about how gifting strategies and longer-term succession planning interact with property equity.
The great wealth transfer is coming – and few families are ready
Around £5.5 trillion is expected to flow between generations in the UK by 2050, according to research from Aberdeen Investments on preparing families for the responsible transfer of wealth. Whalley said the complexity of incoming pension IHT rules, with pensions set to be included in estate calculations from April 2027, means most families are not prepared for what lies ahead.
"The actual process of having pensions in the estate for inheritance tax purposes is going to be an absolute headache for everyone involved," she said. "If you had five pensions, you work out the inheritance tax on those pensions, you go to pay it and you find the sixth pension, you have to go back to the start and do the inheritance tax calculation all over again. If you've only got six months to do that and you've got six pension providers to deal with, it's going to be near impossible for a grieving family member."
For those weighing whether to gift earlier, the case for simplifying the seven-year clawback provision under Bank of Family gifting rules remains an active policy debate.
"The reason the government changed these rules is to enforce a bit of change," Whalley said. "No one likes change, but we do have to embrace it. It's just forcing people not to ignore their financial position anymore."
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