Potentially exempt transfers (PETs)

Giving gifts during your lifetime could reduce inheritance tax (IHT) liability, but only if they qualify as a potentially exempt transfer (PET). In the UK, PETs can be used to pass on assets without an immediate tax bill, depending on how and when the gift is made. On this page, we’ll explain how PETs work, what gifts qualify, and what happens if you pass away within  seven years of giving a gift.

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A potentially exempt transfer (PET) is a transfer made during your lifetime that could be exempt from inheritance tax (IHT) if you live for at least seven years after giving it, although this depends on timing, allowances, individual circumstances and a number of other factors. This could include money, property, or other assets given to an individual, such as a family member or friend.

Introduced by the Inheritance Tax Act 1984, this rule applies to any potentially exempt transfer made in the UK on or after 18 March 1986. Whether or not a gift qualifies as tax-free often depends on timing. The seven-year rule is one determining factor for whether a potentially exempt transfer is included in the giver’s taxable estate.

If the individual dies within seven years of  making the gift, the PET may become a chargeable transfer and its value might then be added to their estate. That could mean inheritance tax is due, depending on the available allowances and the total value involved at the time of death.

If the giver passes away between three to seven years of the gift being made, a rule known as taper relief may reduce the rate of tax owed ( although the original gift amount used in the calculation stays the same). It’s not automatic, and the savings vary depending on when the gift was made.

If someone makes a gift during their lifetime and then dies within three years, the full 40% inheritance tax rate could still apply. From the third year onwards, however, what’s known as taper relief may start to reduce the amount of tax due. This doesn’t change the value of the gift itself, but instead reduces the tax rate used to calculate the potential liability.

The taper relief scale works as follows if the donor passes away between:

• Three and four years: tax rate may fall to 32%

• Four and five years: tax rate could reduce to 24%

• Five and six years: rate drops further to 16%

• Six and seven years: inheritance tax may be as low as 8%

Source: gov.uk/HMRC

Once the gift is more than seven years old, it’s no longer considered part of the person who made the gift’s estate (unless the gift is part of a trust). That means no inheritance tax would typically be due on the amount given away after the gift-giver passes away (with some exceptions).

Learn more about inheritance tax

Qualifying PETs can take many forms, including cash, investments such as stocks and bonds, personal belongings, or property. They’ll only be treated as PETs if the donor gives up all rights to the asset. Gifts between spouses or civil partners are automatically exempt from inheritance tax, regardless of how much they’re worth or when they’re given. Certain trusts can also fall within potentially exempt transfer rules, such as bare trusts or interest in possession trusts that are set up for disabled beneficiaries. A regulated financial advisor can provide guidance on qualifying PETs, including more complex cases involving trusts.

Some transfers don’t meet the criteria for PETs. The most common reason is when the donor still benefits from the asset in some way, despite gifting it (known as a gift with reservation of benefit). For example, they might continue to live in a home they’ve given away without paying rent. In such cases, the asset may still be counted as part of their estate for tax purposes.

Importantly, the gift must be from one individual to another. Transfers made to companies are generally treated as chargeable lifetime transfers (CLTs) and may incur an immediate or future inheritance tax charge*. Transfers to certain types of trusts can also fall in this category.

Other types of gifts, such as charitable donations or wedding gifts within HMRC’s gifting limits, are considered fully exempt and are treated separately from PETs.

Learn more about gift tax in the UK

PETs and CLTs are both ways to give away money or other assets while you’re still alive, but they vary in terms of tax treatment.

• Potentially exempt transfers (PETs) are direct gifts to another person (for example, a child). There’s no tax to pay straight away. If you live for seven years after the gift, it usually stays out of your taxable estate. If you don’t, the gift may become chargeable.

• When a lifetime transfer doesn’t qualify as a PET, it may be deemed a chargeable lifetime transfer (CLT), and this is reported to HMRC as soon as it’s made. CLTs can trigger a 20% IHT charge on amounts that push your total lifetime transfers above the nil-rate band, which is currently £325,000**. The donor is usually responsible for paying this tax, although the recipient can be held liable if it’s unpaid.

PETs offer the potential for full exemption after seven years, while CLTs can create an immediate tax liability.

Not all gifts count as potentially exempt transfers, but some may still benefit from tax-free allowances or other exemptions in certain situations. These tax-free allowances might be deducted as a first step, reducing the taxable sum, before any potentially exempt transfers are considered.

The annual exemption allows individuals to give away up to £3,000 each tax year without increasing their inheritance tax exposure. If the full allowance isn’t used, any unused amount may be carried forward for one year. Small gifts of £250 or less per person, per year, aren’t counted towards this annual limit and don’t affect the PET status.

Learn more about gifting money to children

Following a donor’s death within seven years of making a gift, executors may need to complete a declaration using form IHT 403 and submit it to HMRC. This helps determine whether the asset forms part of the taxable estate. For the declaration, it’s important to include the date of the gift, its value at the time it was made, and details of the person who received it. If these records are missing or incomplete, working out how the gift affects the tax threshold during probate could become more complex.

If the gift is fully covered by allowances, it might not need to be declared. Still, when combined with other gifts over the limit, it could increase the value of the estate for tax purposes. Keeping detailed records of all gifts and seeking professional guidance can be helpful, particularly where gifts span multiple tax years.

Learn more about wills and probate

When a PET fails, i.e. the gift becomes chargeable because the person who made it dies within seven years, the person who received the gift is usually responsible for paying any inheritance tax due.

The HMRC manual states that: “You calculate the tax directly chargeable on a PET by cumulating the values transferred by chargeable transfers in the seven years before the PET”. So tax only applies if the total value of both CLTs and failed PETs made in that period exceeds the nil-rate band (£325,000 - correct at the time of writing) .

In that case, the recipient of the gift is usually responsible for paying the tax on the amount above that threshold, unless the donor’s will specifies that the tax should be paid from the estate instead.

If you’re thinking about how to make the most of your money for the future, it can help to explore your savings options. Raisin UK brings together savings accounts with competitive rates from a range of partner banks and building societies. Find out how it all works and start saving.

*https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm04067

**https://www.accaglobal.com/uk/en/technical-activities/uk-tech/in-practice/2023/january/gifts-and-inheritance-tax.html