Gifting is one of the most effective ways to reduce a potential inheritance tax (IHT) liability
Thousands of families could be paying far more inheritance tax than necessary because they are missing one little-known gifting rule.
With inheritance tax receipts at record levels and further changes due next year, understanding the rules could save families tens of thousands of pounds.
Government receipts from inheritance tax have more than doubled over the past decade as rising property prices and frozen tax thresholds have pulled more estates into the tax net.
From April 2027, unused pension pots will also count towards an estate for inheritance tax purposes, prompting more people to consider gifting as a way of reducing a future tax bill.
One of the least-known rules allows people to make unlimited gifts from surplus income without them being subject to inheritance tax, provided certain conditions are met.
Charlene Young, pensions and savings expert at AJ Bell, said: "You can make unlimited gifts from income that will be free of IHT, provided you can show they form part of your regular expenditure and that they don't reduce your standard of living."
Qualifying income includes earnings, pension income, investment income and savings interest, but not money raised from selling assets.
Ms Young warned: "It's an area where financial advice is invaluable, and paying an adviser could help you avoid costly mistakes.
"Get the rules wrong, and you run the risk of leaving your loved ones with less than you'd hoped for as the gift is still part of your estate."
Anyone planning to withdraw extra money from their pension to fund gifts should proceed with caution, as larger withdrawals could increase their income tax bill or push them into a higher tax band.
In some cases, giving money to a relative to pay into their pension could be a more tax-efficient option, as they may benefit from pension tax relief while the gift also reduces the value of the donor's estate.
For inheritance tax purposes, HMRC treats gifts as "transfers of value", which can include cash, investments, property, artwork and other valuable possessions. Selling or transferring an asset for less than its market value can also count as a gift.
Some gifts are automatically exempt from inheritance tax, including those made between spouses and civil partners, while others qualify for specific tax-free allowances.
However, Ms Young warned that getting the rules wrong could mean gifts are still counted as part of an estate, leaving beneficiaries with a larger inheritance tax bill than expected.
"On the flip side, you could be tempted to give away too much, leaving yourself short and without enough to live on in later life," she said.
Keeping detailed records is also crucial. HMRC expects people to be able to show why a gift qualifies for an exemption, with the burden of proof resting on the person making the gift.
Ms Young said donors should keep evidence of their income and be able to demonstrate they did not reduce their normal standard of living to fund regular gifts.
"Getting hold of bank statements and other records can be difficult without probate, and IHT usually needs to be settled before probate is granted," she said.
She also urged people to make sure their executors know where important financial records are kept, adding: "It might seem onerous, but the value of the IHT exemption certainly makes it worth it."
Ms Young said anyone unsure about the rules should consider seeking professional advice to avoid costly mistakes and help ensure more of their wealth is passed on to loved ones.
