How to give money to children without paying inheritance tax

Financial gifts can be caught in HMRC’s net. Luckily there are several ways to limit your estate’s inheritance tax bill

It’s natural for parents to want to give away some of their wealth to help their children get on in life.
Whether it’s for further education, to get on the property ladder or to fund their own retirement, more money is passing down the generations than ever.
Millennials are on course to become the richest generation in history as Baby Boomers pass on highly valuable investment and property assets.
But giving away money before death – so-called “living inheritances” – is also becoming more popular.
Britain’s inheritance tax rules are complex, however, and there are various traps that could mean your gift is caught by the tax.
The number of estates which attract the 40pc tax charge to rise from around 40,000 this year to almost 50,000 by 2027, according to the Office for Budget Responsibility.
Fortunately, if you are at risk of paying the tax, there are plenty of things you can do to slash your bill.
If on death your estate is worth more than the £325,000 allowance – called the nil-rate band – anything above this threshold will be subject to inheritance tax, charged at 40pc.
If your home is included in your estate and a direct descendant inherits it, your tax-free allowance will be £500,000, thanks to the £175,000 “residence nil-rate band”.
Married couples can get a combined allowance of £1m.
Giving gifts during your lifetime is one of the simplest ways to bring down the value of your estate so it falls within the tax-free allowances.
There are several measures you can take to avoid paying inheritance tax when transferring money to your kids, including:
Taxpayers get a £3,000 annual inheritance tax exemption for gifts to use during their lifetime. Sums up to this cap will not be included when inheritance tax comes to be calculated.
You can “carry forward” any unused allowance into the following tax year. So, if you didn’t use it all in 2024-25, you could pass on up to £6,000 in 2025-26. The allowance can be used on one person or spread across several, so you don’t have to choose one of your children over another.
There is also a £250 “small gifts” allowance per tax year. This allowance is per person, but you can give up to £250 to as many people as you like. Birthday and Christmas gifts made from regular income are also exempt.
You can give up to £5,000 to a child or £2,500 to a grandchild for wedding expenses in each tax year. This is in addition to the standard annual allowance, but not the small gifts allowance. So you could give £11,000 towards a wedding in one tax year (assuming you could carry forward a year’s worth of allowances).
If you want to give more than this, the seven-year rule will usually apply.
Some gifts might start out as liable for inheritance tax but, over time, they drop out of your estate.
These are technically known as “potentially exempt transfers”, or more commonly the seven-year rule – because gifts (of any value) made seven years or more before death are entirely free of inheritance tax.
This means you must survive the gift by seven years in order for it to be free from inheritance tax.
If you die within seven years, a taper applies (see table, above) so you won’t pay the usual 40pc tax charge.
The taper and seven-year rule is irrelevant if the total value of gifts you make is below the £325,000 nil-rate band.
One of the most lucrative – but little-used – inheritance tax breaks is the “gifts out of surplus income” rule.
Only 430 families used this loophole in 2022, according to a Freedom of Information request submitted by The Telegraph.
The rule allows any taxpayer to give away unlimited sums of money without getting caught by inheritance tax – as long as the gifts do not diminish their quality of life and the money comes out of income, not capital (such as savings or investments).
Proving that a gift qualifies for this relief is not as simple as it might seem.
You need to show that the gifts have not had an adverse effect on the gifter’s life and that they are “normal” – that is, that it was regular or at least there was a plan for it to be regular.
That does not necessarily mean the gifts have to be of the same size. For instance, it might be that you gift the dividends from an investment portfolio, that may fluctuate over time.
As with many aspects of the inheritance tax regime, keeping detailed records make it far more likely HMRC will accept the relief does apply.
Mike Warburton, the Telegraph’s tax columnist, has previously written about the relief.
He says the legislation governing the relief is brief and “there is no reference to the records that should be kept.”
He says: “The simple answer is that the more detailed records you can keep, the better scope for relief to be granted.
“Ideally you should keep bank statements and other documents so that for each year you could produce a summary of your income and your expenditure, rather like a simple profit and loss account for a small business.”
Setting up a trust allows you to give away money without relinquishing all control. Depending on how the trust is set up, you can specify how the money is used while the trustees you have appointed have ultimate control.
Often trusts are set up to look after the interests of children or vulnerable people who cannot manage their own affairs. “Bare” and “discretionary” trusts are the most common types, and the seven-year rule applies here, too.
Money put into a trust falls out of your estate for inheritance tax after seven years. However, a 20pc tax charge may apply when setting up a trust with money that exceed the inheritance tax nil-rate band, £325,000 per person.
The Government has provided a useful example of how different gifts would attract inheritance tax:
Sally died on 1 July 2022. She was not married or in a civil partnership when she died.
She gave three gifts in the nine years before her death:
There’s no inheritance tax to pay on the £50,000 gift to her brother as it was given more than seven years before she died.
There’s also no inheritance tax to pay on the £325,000 she gave her sister, as this is within the inheritance tax threshold.
But her friend must pay inheritance tax on her £100,000 gift at a rate of 32pc, as it’s above the tax-free threshold and was given three years before Sally died. The inheritance tax due is £32,000.
Sally’s remaining estate was valued at £400,000, so the estate would pay inheritance tax of 40pc on £400,000 (£160,000).
An important distinction to note is where a gift is made but the donor continues to benefit or enjoy it. This most commonly is a problem when someone gives away a property but continues to live in it without paying market rent. Paying the going rent, however, would mean it was a true gift.
Accountants warn that family heirlooms such as jewellery, art, antiques and so on, can even be caught by HMRC’s inheritance tax inspectors if it believes the object haven’t truly been given away.
Again, clear and detailed records will help your executors.
Children’s savings accounts are a good way to build up cash, and often offer higher rates than standard accounts. However, unless the money is held in a Junior Isa, you may have to pay a tax bill if the interest on the child’s account exceeds £100 a year.
Luckily, interest on gifts made by grandparents, other family members or friends does not count towards the £100 limit. And if you haven’t used up your own personal savings allowance (£500 a year for a higher-rate payer, £1,000 for basic-rate payers) this can also be set against the £100.
Child Trust Funds are also exempt from the rule.
You can benefit from tax relief when inheriting certain assets, including:
Business owners and investors can qualify for either 50pc or 100pc relief on inheritance tax on a business or shares in an unlisted company. There are some exceptions, such as if the company is mainly an investment company, and business relief cannot apply if agricultural relief (see below) also applies.
Increasingly people invest in shares listed on the Aim (alternative investment market), which can qualify for this relief.
Note that from April 2026, the relief will be reduced from 100pc to 50pc, meaning you’ll pay an effective 20pc tax rate on these returns over the tax-free allowance.
Working farmland and property can qualify for an exempt from inheritance tax if it meets certain conditions, but livestock, farm equipment and other property does not.
This relief is changing from April 2026, too. From this point, there will be no inheritance tax charged on combined business and agricultural assets worth less than £1m, but above this the relief is being reduced to 50pc – again, levying an effective tax rate of 20pc.
If woodland does not qualify for business relief or agricultural relief, it may qualify for woodland relief. Where it applies executors can elect to exclude the value of the trees, but not the land itself, from the value of the estate.
Certain assets, including buildings, land or art, can be free both of inheritance tax and capital gains tax when they pass to a new owner either as a gift or on death. The exemption only applies if the assets have “outstanding” significance, such as an historic building or land with spectacular views or special scientific interest.
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Before we look at the rules around the tax on gifts and the amounts you can potentially give away tax free, it’s important to understand what, exactly, constitutes a gift.
As far as HMRC is concerned, a gift could be any of the following:
The annual exemption for IHT gifts is only £3,000 a year and you can choose to give that to one person or spread it across several people. However, bear in mind that if you didn’t use last year’s allowance, you can give away £6,000 this year.
It’s also possible for parents to join forces when they give money to their children. This means you can give away as much as £12,000 this year between you (or £3,000 each for four children), if neither of you used your annual exemption last year.
The rules on gifting for IHT purposes are strict, which means any gift you make must be outright. If you give away something but continue to get some benefit from it, it would still be considered part of your estate and, potentially, be subject to tax.
Examples of so-called “gifts with reservation of benefit” would include, giving away a house but continuing to live in it, or a piece of jewellery that you continue to wear.
Sorting out an estate after someone has died isn’t always easy, especially if there’s an inheritance tax bill to pay and the deceased made gifts during their lifetime.
You can save your executors a lot of stress and hassle by keeping detailed records of the gifts you make, including the date and value of the gift, as well who you gave it to. Record keeping is particularly important if you are making gifts from surplus income – in which case you will need to show details of your income and expenditure in addition to details of the gift itself.
Taking a look at the forms your executors will need to complete, will give you a better idea of the details they will need.
Your parents can give you £50,000, but if they die in the next seven years you will have to pay tax up to 40pc.
Take a look at our section on potentially exempt transfers for more information.
There is no need to declare any cash gifts that you receive in a self-assessment tax return, however, you and the donor should be aware of any inheritance tax you may have to pay.
Detailed records of any gifts made will make it much easier to claim for inheritance tax relief.