PET vs CLT: Understanding Two Common Ways to Pass on Wealth During Your Lifetime
Many people want to help their children or future generations while they are still alive. Lifetime gifting can be an effective way to reduce the value of an estate for Inheritance Tax purposes, but different gifting options come with different tax consequences and responsibilities.
Two of the most common approaches are:
- Making a gift directly to an individual, known as a Potentially Exempt Transfer (PET)
- Transferring assets into a discretionary trust, known as a Chargeable Lifetime Transfer (CLT)
Understanding how these options work can help you make informed decisions as part of a wider estate planning strategy.
Why the Structure of a Gift Matters
A common misconception is that all lifetime gifts are treated the same for Inheritance Tax purposes. In reality, the timing of any tax, who is responsible for paying it, and the administrative requirements can vary significantly depending on how the gift is made.
While the overall tax outcome may sometimes be similar, the route taken can have important practical implications for both the donor and their family.
Gifting Directly to Family Members
A gift made directly to an adult child or another individual is generally treated as a Potentially Exempt Transfer. In most cases, there is no Inheritance Tax to pay when the gift is made.
The position changes if the donor dies within seven years of making the gift. The gift may then become chargeable for Inheritance Tax purposes and be considered alongside the rest of the estate when calculating any tax liability.
This can create an unexpected liability for the person who received the gift, as they may be responsible for paying the tax attributable to that transfer.
Using a Discretionary Trust
A discretionary trust can offer flexibility and control, particularly where assets are intended to benefit multiple family members or future generations.
Unlike a gift to an individual, a transfer into a discretionary trust is usually chargeable immediately for Inheritance Tax purposes. This means there may be a tax payment during the donor’s lifetime and reporting requirements to HMRC.
If the donor dies within seven years, the transfer is reviewed again and additional tax may become payable depending on the circumstances.
Trustees are typically responsible for dealing with the tax associated with the trust, while the executors remain responsible for any tax arising on the estate itself.
It is also important to remember that discretionary trusts are subject to their own ongoing tax regime and can attract periodic and exit charges in the future.
Example: How Two Different Strategies Can Lead to the Same Tax Outcome
Consider a parent who wishes to transfer £800,000 to the next generation. They can either gift the money directly to an adult child or place it into a discretionary trust.
If the parent dies just over three years later, both arrangements can produce the same overall Inheritance Tax liability. However, the journey to that outcome is very different.
With a direct gift, no tax is usually payable when the gift is made. If the donor dies within seven years, the recipient may become responsible for the tax attributable to that gift.
With a discretionary trust, an Inheritance Tax charge can arise immediately when the transfer is made, and the trust must normally be reported to HMRC. If the donor dies within seven years, the position is recalculated and additional tax may become payable. Responsibility for dealing with that tax will usually fall on the trustees.
In the example both approaches resulted in a total Inheritance Tax liability of £192,000. The key differences were not the overall tax bill, but when the tax became payable, who was responsible for paying it, and the ongoing administrative obligations involved.
Looking Beyond the Tax Figure
In the example both a direct gift and a transfer into a discretionary trust ultimately produced the same overall Inheritance Tax liability.
The key differences were:
- When tax became payable
- Who was responsible for paying it
- Whether reporting to HMRC was required during the donor’s lifetime
- The longer-term obligations that apply to trusts
This highlights an important point. Effective estate planning is not simply about reducing tax. It is about choosing the structure that best reflects your family circumstances, objectives and appetite for ongoing administration.
Taking a Strategic Approach to Estate Planning
Large gifts of cash, investments or property should rarely be considered in isolation. Decisions about when to give, who should benefit, and whether a trust structure is appropriate can have lasting consequences for both the donor and their family.
A well-planned strategy can help:
- Provide financial support to loved ones sooner
- Create clarity around future succession plans
- Manage potential Inheritance Tax exposure
- Protect family wealth across generations
- Reduce the risk of unexpected tax or administrative issues
Every family’s circumstances are different, and the most suitable approach will depend on your wider assets, objectives and future plans.
How RLK Can Help
Lifetime gifting can be a valuable part of estate planning, but the rules are complex and the right solution is rarely one size fits all.
At RLK Solicitors, we help individuals and families assess their options, understand the implications of different gifting strategies, and put practical plans in place with confidence. Whether you are considering a straightforward gift to a family member or a more structured trust arrangement, we can guide you through the process and help ensure your planning aligns with your long-term goals.
This article is intended as general information only and should not be relied upon as legal or tax advice. Specialist advice should be obtained based on your individual circumstances.
