Can we afford to take our family on an annual holiday without falling into the inheritance tax trap?

My husband and I are in our 70s, in good health, and have no financial worries. We don’t like extravagant holidays or expensive cars, but we do have a good lifestyle.

We eat well and probably spend a lot more on quality, healthy food than the average couple, but we also drive a moderate car.

We have three children and five grandchildren. Our three children received £50,000 each to help them buy houses more than seven years ago.

We hesitate to give away more, since our mothers lived to be 100 years old.

However, I thought that if we enjoyed family holidays every year and paid the cost, this would be a way for our savings to go to the family, but would this be considered evasion of inheritance tax?

If so, is there a way to use our savings for the benefit of our family, without it being a problem in the future? BT by email

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This is Money’s Harvey Dorset responds: Vacations are a great way to see the benefit your family can get from your money and feel more personal than simply giving them a lump sum of cash.

Unfortunately, paying for a family vacation would likely be considered a gift, meaning the seven-year rule would apply.

However, with a gift allowance of £6,000 between you and your husband, or possibly more if you haven’t used your previous year’s allowances, as well as the option to make tax-free gifts of £250 to as many different people as you. If you want, you may be able to fully or at least partially fund the family vacation with your gift allowance.

If you are already gifting money to your children within your allowances, this would mean that you will not be able to use holiday pay as a means to give beyond your annual allowances.

If you are both in good health, now would be the time to give more gifts to your family or pay for a vacation, as they will be more likely to live more than seven years after the gift was given.

The later you leave it, the greater the risk of having to pay inheritance tax in the future.

One option to consider if you don’t choose to pay a holiday is to make the most of your giving allowance each year to continue giving to your children and their children.

This is Money spoke to two financial advisors to find out what you need to know before taking your family on vacation.

Responsibility: Chris Peters warns that taking his family on vacation could be considered a gift

Chris Peters, Independent Financial Advisor at Flying Colors, responds: Funding a family vacation each year is a generous gesture, but it’s important to ensure your own financial future and lifestyle needs are secure.

With good health and an above-average life expectancy, it is essential that you find the right balance between maintaining your current expenses and safeguarding your long-term financial security, before taking your family on a vacation.

You should consider your guaranteed sources of income, such as state pensions, annuities or final salary pensions.

Indexed annuities can protect against inflation, but if you have a drawdown pension, market declines could hit your capital and low-risk funds may not be able to keep up with inflation.

This could put your income in retirement at risk, so it’s important to periodically review your income strategies as the years go by.

Your savings may be needed for income or for larger one-time expenses in the future, like replacing your car. It is essential to have enough cash for emergencies (typically three to six months to cover living expenses).

In short, make sure you retain enough funds after paying for family vacations to cover unexpected costs as well as your daily living expenses.

Family holidays and HMRC gifting rules

In your question, you mention inheritance avoidance. To clarify, inheritance tax will only be payable on death if your joint estate is worth more than £1 million.

If that’s the case, then you should pay attention to HMRC’s gift rules before you go ahead and pay for future family holidays.

Paying for a family holiday could be considered a gift under HMRC rules, depending on how the payment and cost of the holiday is structured.

Please note that the donation rules are based on the 2024/25 tax year. This is how they can be applied:

1. Small donation exemption: You can gift up to £250 per person per year to as many people as you like, but if the cost of the holiday exceeds £250 per person this exemption does not apply.

2. Annual Donation Exemption: You can gift up to £3,000 per tax year without it being counted in your estate for inheritance tax purposes. If not used, the exemption can be carried forward to the next tax year, giving you a potential allowance of £6,000.

3. Normal expense charged to income: If you can afford the vacation with your excess income (after paying living expenses), you may qualify for the normal out-of-income expenses exemption. However, you will need to keep records to show that the gift does not affect your standard of living.

4. Potentially Exempt Transfer (PET): If the cost of the vacation exceeds your exemptions, it may be treated like a pet. If you live seven years after the gift, it will be exempt from inheritance tax. If you die within seven years, the gift may be subject to IHT, although a gradual reduction may apply.

Family holiday pay may be tax-free if it falls within certain gift exemptions, such as the annual allowance or small gift exemption.

Otherwise it could be treated as a PET, subject to inheritance tax if you die within seven years.

Remember: always make sure your financial needs are protected, maintain enough savings for emergencies, and use your giving allowances within each fiscal year (April 6-5).

Not a priority: Olly Cheng says if you expect to live longer than seven years then IHT shouldn’t be your biggest worry

Olly Cheng, director of financial planning at Rathbones, responds: It sounds like you have two different problems here.

One is how much you can afford to use to help your children and grandchildren, and the second is that when you help them, you would like it to be tax efficient.

Firstly, if you think you can afford to take the whole family on vacation, this is often a great way to use your money.

This is not because of any tax benefits, but because it is a fantastic way for all three generations of your family to benefit and spend quality time together.

As well as this, it can mean your children save more if they don’t spend money on a separate holiday they would have otherwise bought.

Paying for a vacation for the entire family would be a gift for inheritance tax purposes; However, there is a good chance that it will be out of your estate immediately due to the size of the gift.

Each of you is entitled to give £3,000 each year (i.e. £6,000 between you) which falls immediately out of your estate, as well as smaller gifts of £250 per person each year.

Additionally, if your income exceeds your normal expenses, regular gifts from the excess income are immediately removed from your estate.

These subsidies will cover some, if not all, of the cost of taking your family on vacation.

If part of the cost exceeds the thresholds, there is nothing to worry about. It would not be considered tax evasion, but would have to be declared as part of the probate process if you died within seven years.

In your circumstances, you both expect to live longer than another seven years given your family history, so inheritance tax should not be a major concern if you want to have a big family holiday. As long as it’s affordable it’s a great idea.

Regarding your finances in general, it might be worth doing a detailed exercise to see what you will really need if you live to be 100.

Making a decision now about whether you would be willing to release equity or downsize your home, whether as part of your plan or as a last resort, will make a big difference in the amount of equity you will need to retain for your old age.

Ultimately, doing proper cash flow forecasting and scenario planning is the best way to avoid problems in the future and, if done correctly, will give you the freedom and peace of mind to provide more help to your family now.

Financial planning is always a delicate balance between saving and spending, but giving yourself the freedom to spend, gift, and enjoy the money you’ve worked hard to save is as important a part of the process as having saved in the first place.