Inheritance tax gifting rules explained as Rachel Reeves' Budget shake-up could cut how much you pass on tax-free

Treasury officials are considering new measures to boost inheritance tax revenue as they grapple with a funding gap of more than £40billion ahead of the autumn Budget, according to Government sources.

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One proposal under review is the introduction of a lifetime cap on tax-free gifts, which would limit how much wealth can be transferred before death without triggering a tax bill. The idea comes as inheritance tax receipts are projected to almost double, rising from £8billion this year to £14.3billion by 2029/30, driven by frozen tax thresholds and changes to pension taxation rules.

At present, any gifts made more than seven years before death are fully exempt from inheritance tax. Gifts made between three and seven years before death qualify for taper relief, with the tax rate gradually falling from 32 per cent to eight per cent over that period.

A Government source said: "With so much wealth stored in assets like houses that have shot up in value, we have to find ways to better tap into the inheritances of those who can afford to contribute more."

Sarah Coles, head of personal finance at Hargreaves Lansdown has explained the vital things people need to know before they think about gifting to beat any type of tax traps coming up.

Inheritance tax gifting rules

Under current rules, individuals can give away up to £3,000 each tax year without it being counted as part of their estate for inheritance tax purposes. If the previous year’s allowance has not been used, it can be carried over, allowing tax-free gifts of up to £6,000 in a single year.

There are also exemptions for small gifts of up to £250 per person to any number of people, though this cannot be combined with the annual £3,000 allowance for the same recipient.

Wedding and civil partnership gifts have their own limits - £5,000 for children, £2,500 for grandchildren or great-grandchildren, and £1,000 for other recipients.

In addition, regular gifts from surplus income are exempt, provided they are funded from ongoing earnings, pensions, rental income, interest or dividends, rather than savings.

To qualify, the donor must show a clear pattern of giving and keep detailed records to demonstrate the payments are genuinely from excess income.

Larger gifts are treated as "potentially exempt transfers" and only become free from inheritance tax if the donor survives for seven years after making them.

If the donor dies within that period, the gift may be taxed, with any amount above the £325,000 nil-rate band potentially incurring inheritance tax payable by the recipient.

Financial planning experts caution against making rushed decisions to cut future tax bills. One of the most common mistakes is giving away too much too soon, leaving insufficient funds to cover living costs later in life.

Property transfers can be especially complex. Homeowners can gift their property to children, but to remove it from their estate, they must move out and take no further benefit from it. As with other large gifts, the seven-year rule applies.

If the donor continues to benefit from the property – for example, by living there rent-free or imposing restrictions on its sale – it becomes a "gift with reservation of benefits", meaning it remains part of the taxable estate.

Trust-based schemes promoted as ways to pass on property may also backfire. HMRC could view these arrangements as tax avoidance, leaving the donor with wasted setup costs and potential immediate tax liabilities, without reducing the estate’s taxable value.

The Treasury's review of gifting regulations comes amid calls for comprehensive reform of the inheritance tax system. Rachael Griffin, tax and financial planning expert at Quilter, cautioned that modifications to gift rules should address the frozen allowances that have remained unchanged since the 1980s.

"Reform should be proportionate and targeted at genuine avoidance, while ensuring families can continue to provide support without fear that normal acts of generosity will be swept into the IHT net," Ms Griffin said.

She noted that previous recommendations from the Office of Tax Simplification suggested reducing the gift exemption period from seven to five years whilst eliminating taper relief to streamline the system. A lifetime cap would contradict these simplification efforts by introducing additional complexity.

The source familiar with Treasury discussions acknowledged: "It's hard to make sure these taxes don't end up with loopholes that undermine their purpose. But we are trying to work out what revenue might be raised and how to ensure it's a fair approach."

Despite uncertainty over potential reforms, financial advisers point out that there are still legitimate ways to manage inheritance tax exposure. For example, individuals who do not currently have surplus income can invest in assets that generate dividends, which can then be gifted while meeting the rules for regular gifts from income.

Annuities offer another avenue for estate planning. Purchasing a joint life level annuity creates income that can fund premiums for whole of life insurance policies established in trust.

This arrangement removes the annuity funds from the estate whilst ensuring beneficiaries receive tax-free payouts upon death.Ms Coles emphasised the importance of understanding current regulations:

"Inheritance tax is a strange beast, so before you get started it's vital to understand the rules and avoid the common mistakes."

She noted that record tax bills are encouraging people to "give with a warm hand rather than a cold one" to reduce their estates before falling under tax scrutiny.