Definition
The Annual Exemption is the £3,000 allowance each person can give away each tax year (6 April to 5 April) without those gifts being added to their estate for inheritance tax purposes.
Choosing when and how to use this exemption strategically can help reduce your estate's value over time, ensuring more of your wealth reaches your loved ones rather than being reduced by inheritance tax.
What Does Annual Exemption Mean?
The Annual Exemption, established under Section 19 of the Inheritance Tax Act 1984, allows each person to give away up to £3,000 worth of gifts in any tax year (running from 6 April to 5 April) without those gifts being counted as part of their estate for inheritance tax purposes. Unlike Potentially Exempt Transfers, which require you to survive seven years for the gift to become fully exempt, gifts covered by the annual exemption are immediately outside your estate. You can give the full £3,000 to one person—such as helping an adult child with a house deposit—or split it among multiple recipients, perhaps giving £1,000 each to three different grandchildren.
The exemption includes a valuable carry-forward rule that many people don't realise exists. If you don't use your full £3,000 allowance in one tax year, the unused amount carries forward to the next year only. This means you could potentially give up to £6,000 tax-free in a single year. However, you must use your current year's exemption first before applying any carried-forward amount. For example, Sarah didn't make any gifts in the 2023/24 tax year, so her full £3,000 exemption went unused. In December 2024, she gave her daughter Emma £5,500 for her wedding. The first £3,000 uses Sarah's 2024/25 exemption, and the remaining £2,500 uses part of the carried-forward £3,000 from 2023/24. The entire £5,500 gift is immediately exempt from Inheritance Tax.
The annual exemption works alongside other inheritance tax exemptions, meaning you can be strategic about Lifetime Gift. For instance, you could give your son £3,000 using your annual exemption, plus give him a £5,000 wedding gift (which has its own separate exemption), and separately give his wife £250 using the Small Gifts Exemption—all in the same tax year, all completely inheritance tax free. Married couples and civil partners each have their own £3,000 annual exemption, so together they can give away £6,000 per year (or £12,000 if they didn't use the previous year's allowances). It's worth noting that the annual exemption has remained at £3,000 since 1981, meaning its real value has decreased significantly over time due to inflation.
Common Questions
"Can I give my daughter £5,000 this year without paying inheritance tax if I didn't make any gifts last year?" Yes. You can use this year's £3,000 annual exemption plus last year's unused £3,000 exemption, totaling £6,000. Since your gift is £5,000, the entire amount is immediately exempt from inheritance tax. The remaining £1,000 of combined exemption is lost—it cannot be carried forward further.
"If I give £3,000 to each of my three children every year, will that be tax-free?" No. Your annual exemption is £3,000 total, not £3,000 per recipient. You would need to split the £3,000 among your three children (for example, £1,000 each). Any amount above your £3,000 annual exemption becomes a Potentially Exempt Transfer, which is only tax-free if you survive seven years.
"My partner and I want to help our son buy his first home. How much can we give him tax-free this year?" As a couple, you each have your own £3,000 annual exemption, so you can give your son £6,000 immediately tax-free this year. If neither of you made gifts last year, you can use the carried-forward exemptions too, giving up to £12,000 total without inheritance tax implications.
Common Misconceptions
Myth: I can give £3,000 to each of my children tax-free every year.
Reality: The annual exemption is £3,000 total per tax year, not £3,000 per recipient. If you have three children and want to give them equal amounts using only your annual exemption, you could give each of them £1,000. If you give £3,000 to each child (£9,000 total), only the first £3,000 is covered by your annual exemption—the remaining £6,000 would be a Potentially Exempt Transfer, subject to inheritance tax if you die within seven years.
Myth: I can save up my annual exemption over several years and make a big tax-free gift later.
Reality: You can only carry forward one year's unused annual exemption, and it must be used in the immediately following tax year or it's lost forever. The maximum you can ever give using the annual exemption in a single tax year is £6,000 (your current year's £3,000 plus the previous year's unused £3,000). You cannot accumulate exemptions from multiple years.
Related Terms
Understanding Annual Exemption connects to these related concepts:
- Inheritance Tax: The annual exemption is one of several exemptions designed to reduce or eliminate inheritance tax liability on your estate.
- Lifetime Gift: The annual exemption is a specific type of lifetime gift exemption that allows immediate tax-free transfers during your lifetime.
- Potentially Exempt Transfer: When a gift exceeds the annual exemption (and other available exemptions), the excess becomes a Potentially Exempt Transfer, which is only tax-free if the donor survives seven years.
- Small Gifts Exemption: This complementary exemption allows unlimited gifts of up to £250 per person per tax year, but cannot be combined with the annual exemption for the same recipient.
Related Articles
- Article on Inheritance Tax Planning: Discover how the annual exemption fits within a comprehensive inheritance tax planning strategy.
- Mid-Career Estate Planning Guide: Learn how to use the annual exemption proactively during your prime earning years to reduce your future estate.
- Understanding Tax-Free Gifting: Explore how to combine the annual exemption with other exemptions for maximum tax-efficient giving.
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Legal Disclaimer: This glossary entry provides general information about the Annual Exemption and does not constitute legal or tax advice. Inheritance tax rules can be complex, and everyone's circumstances are different. For advice specific to your situation, consult a qualified solicitor or tax adviser.