Technically, this strategy applies to most gifts in excess of £250, but obviously a small gift of that kind does not create much of a tax saving in your estate. Much larger gifts, however, can have a considerable effect.
Any large gift you make is known in technical language as ‘potentially exempt’ - meaning that it will be taxed if you die within seven years, but it has the potential to become exempt from tax if you survive the seven years. (You’ll sometimes hear lawyers talk about a “PET”, which is an abbreviation of “Potentially Exempt Transfer”, and is usually just another way of talking about a large gift.)
For the very wealthy, this is the most important tax saving strategy. There is no limit to the size of gift you can make (for example to your own children) and if you survive the seven years it will be tax free.
If the gift does eventually become taxable, because you die within the seven years, then it will be taxed on a sliding scale. This is called “taper relief”. If you survive three years from making the gift the rate of tax falls by a fifth, from 40% to 32%. If you survive four years it is 24%, five years is 16%, and six years is 8%. It is very easy to become misled by this sliding scale however. If the original gift was within your nil band then the sliding scale will never apply to it. It is only larger gifts which get this advantage. (If you’re interested, this is because it’s not the value of the gift that tapers, it’s the rate of tax that tapers: and the nil rate band gets its name because it’s taxed at “nil-rate” i.e. 0%. And however much you taper 0%, it is still 0%. People imagine, for example, that if they make a £100,000 gift and survive three years, they’ll be taxed as if they had made an £80,000 gift and therefore save tax on £20,000 from their death estate. But they are wrong. They have to survive 7 years for their saving: and of course if they do survive that long the gift is out of the tax estate completely.)
There is a school of thought which says that those with considerable wealth should give away to younger generations of the family as much as they can afford to give away, and as young as they are able to do it. However, this must be a matter for your personal choice, and it would obviously be wrong to make gifts which were not prudent or which left you exposed to financial difficulties later in your life.
There is no financial limit to Potentially Exempt gifts. You can gift fifty billion pounds tax free, if you have that sort of money lying around.
A WORD OF WARNING: It quite often happens that people with inheritance tax problems don’t have any assets to “tax plan” with, except those which they need for themselves. A good example of this is the widow who only has the house and a portfolio of investments, and she lives off the income which those investments produce. It is tempting to transfer the house and investments into the names of the children. The problem with this arrangement is the “gift with reservation” rule. This rule says that if you give something away, but continue to receive some benefit from it, then it stays in your tax estate. You’ve given away your financial security and have got no benefit whatsoever from it. You will be living for the rest of your life off the charity of your children, and in the event they may prove not to be as charitable as you hope. (If you need more advice about this problem, you might like to read a play called “King Lear”, which is available from most good bookshops.) That’s not to mention the horrendous consequences which would follow if one of your children died before you, or became divorced, or lost their mental capacity, or went bankrupt.
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