Why Gifting is an Essential Part of Estate Planning: Wills, Powers of Attorney, and Avoiding the 7-Year Rule
When it comes to estate planning, most people think about writing a will or setting up a power of attorney (LPA), but gifting is often overlooked as a powerful tool in ensuring that your assets are passed on to your loved ones efficiently and tax-effectively. Gifting allows you to pass on wealth during your lifetime while also reducing the size of your estate, which can help minimize the impact of inheritance tax (IHT).
In this post, we’ll explore how gifting works within the broader context of estate planning, including wills and powers of attorney, and how careful planning can help you avoid falling foul of the 7-year gifting rule.
Gifting as a Key Element in Estate Planning
Estate planning involves more than just writing a will or setting up an LPA. It’s about making thoughtful decisions to ensure that your wealth is transferred to the right people at the right time, with as little tax as possible. Gifting is a critical component of this, as it allows you to start transferring wealth while you’re still alive, giving you more control over how your assets are distributed.
When done strategically, gifting can work hand-in-hand with your will and powers of attorney to create a comprehensive plan that covers both your lifetime and what happens after your death. This holistic approach ensures that your assets are managed effectively, your wishes are respected, and your loved ones are protected from unnecessary tax burdens.
The Importance of Gifting in Relation to Wills and Powers of Attorney
While wills ensure your estate is distributed according to your wishes after you pass away, and LPAs give trusted individuals the authority to manage your affairs if you lose capacity, gifting allows you to take immediate action in distributing your wealth. By making gifts during your lifetime, you can:
Reduce the overall size of your estate, which may lower the potential IHT bill.
Directly benefit your loved ones when they may need it most, such as helping with home purchases or educational expenses.
Take advantage of the gifting allowances available under UK law to make tax-free gifts, ensuring your beneficiaries receive more of your wealth without the risk of inheritance tax.
However, without careful planning, gifts made in your lifetime can be subject to IHT if they fall within the 7-year rule. That’s why it’s crucial to be aware of the available gifting exemptions and how they fit into your wider estate planning strategy.
Understanding the 7-Year Rule
The 7-year rule is a key factor to consider when gifting. If you make a gift and pass away within seven years, that gift could still be considered part of your estate and subject to IHT. However, if you live for more than seven years after making the gift, it is exempt from IHT. This is why it’s important to plan gifting ahead of time, especially if you’re considering giving away larger sums of money or assets.
If the total value of gifts given in the seven years before your death exceeds the IHT-free threshold (the nil-rate band, currently £325,000), IHT may be charged on the gifts. The amount of tax depends on how many years before your death the gift was made, with taper relief reducing the tax owed over time.
Available UK Gifting Allowances
To avoid the complications of the 7-year rule, the UK offers several gifting exemptions that allow you to make tax-free gifts. These exemptions work well as part of your estate planning, enabling you to gradually reduce your estate while benefiting your loved ones during your lifetime.
1. Annual Exemption: £3,000 per Year
You can give away up to £3,000 each tax year without incurring any IHT. This is known as the annual exemption, and it can be carried forward for one year, allowing you to gift up to £6,000 if you haven’t used the previous year’s exemption.
2. Small Gifts Exemption: £250 per Person
You can give up to £250 to as many individuals as you like each tax year, as long as they haven’t benefited from your £3,000 annual exemption. This is ideal for making smaller, regular gifts to family members and friends.
3. Wedding or Civil Partnership Gifts
You can also make tax-free gifts to individuals getting married or entering into a civil partnership:
Parents can gift up to £5,000.
Grandparents can give up to £2,500.
Anyone else can give up to £1,000.
4. Gifts from Surplus Income
Regular gifts made from surplus income, rather than capital, are also exempt from IHT under the normal expenditure out of income rule. These gifts must not affect your own standard of living and should be part of a regular gifting pattern, such as monthly or annual gifts to children or grandchildren.
5. Charitable Gifts
Any gifts to registered UK charities are free from IHT. Additionally, if 10% or more of your estate is left to charity in your will, the IHT rate on the remainder of your estate can be reduced from 40% to 36%.
Integrating Gifting with Powers of Attorney
If you have a lasting power of attorney (LPA) in place, particularly for Property and Financial Affairs, your attorneys can manage your finances if you lose mental capacity. However, their ability to make gifts on your behalf is limited to the exemptions available under UK law unless the Court of Protection gives additional authority.
This makes it even more important to plan gifting while you still have full control over your financial decisions. By doing so, you can ensure that gifts are made in line with your wishes and maximize the available exemptions, reducing the need for your attorneys to make complex financial decisions on your behalf.
How to Plan Gifting as Part of Your Estate Strategy
Maximize Your Annual Allowances Make the most of the £3,000 annual exemption and other available allowances, such as wedding gifts and small gifts, to gradually reduce your estate without triggering IHT. This can also help avoid the complications of the 7-year rule.
Start Gifting Early For larger gifts, planning ahead is essential. The sooner you make substantial gifts, the greater the chance they will fall outside the 7-year window and become fully exempt from IHT. If you’re considering larger lifetime gifts, it’s worth consulting with an estate planning expert to help you structure these gifts effectively.
Document Everything Clear records of all gifts made, including dates and amounts, will help your executors manage your estate and ensure that gifts are handled correctly when calculating IHT liabilities.
Coordinate with Your Will Make sure that your gifting strategy is aligned with the instructions in your will. For example, if you’ve made significant lifetime gifts to one beneficiary, you may want to adjust how assets are divided in your will to ensure fairness among your heirs.
Final Thoughts
Gifting is a vital part of estate planning, working alongside wills and powers of attorney to help you manage your wealth efficiently and minimize inheritance tax. By understanding the gifting allowances and planning ahead to avoid the 7-year rule, you can ensure that your loved ones receive the maximum benefit from your estate—both during your lifetime and after.
For tailored advice and to ensure your gifting strategy complements your overall estate plan, it’s a good idea to seek professional guidance from an estate planning professional or financial adviser.
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