Many people are paying too much inheritance tax
A simple way of reducing your potential IHT liability is to consider making gifts out of your estate during your lifetime. The Private Client Tax Team at Wheelhouse outline a few straightforward, yet effective options to consider in this article.
The easiest type of asset for an individual to give away is cash as it does not have any capital gains tax implications.
An individual can make various types of gift during their lifetime that fall outside the scope of inheritance tax. These include:
- Each individual has an annual exemption for gifts for IHT purposes of £3,000 per tax year. Should this not be used in one year, it may be utilised in the following year but not carried forward any further
- Gifts between husband and wife (or civil partner) are completely free of IHT
- Gifts can also be given on the occasion of marriage. If an individual’s child is to be married, a gift of £5,000 can be made and for grandchildren, £2,500 can be gifted. For anyone else, a gift of up to £1,000 can be made free of IHT
- Gifts can be made to charities or political parties free of inheritance tax. Qualifying charities must be UK or EU registered
- Gifts out of surplus income
Should an individual have income in excess of their needs, the surplus income may be given away free of IHT provided that the individual can demonstrate that that it is a gift out of income.
In order for the gift to qualify it must be made out of income and not capital. It must be normal expenditure and the standard of living of the individual making the gift must not be diminished in any way. There must also be a regular pattern of gifts being made but the gift does not need to be made to the same person each time, so it is possible to spread across a number of children.
It’s possible that a single gift could qualify so long as it can be proved upon death that there was an intention to continue with the payments. Such intention could be proved by the donor providing a signed letter to the recipient confirming their intention to continue to make regular payments.
This is a particularly effective means of tax planning if an individual is not dependent upon such income to maintain their current standard of living but wish to retain control of their capital. For example, a parent could pay the premiums on a life policy for their child, make payments in to trust for the benefit of their children, or pay their children’s school or university fees.
The gift can be made out of general income or it could be made out of a nominated source such as property rental or specific investment income.
Potentially exempt transfers
Potentially exempt transfers are a popular way for wealthy individuals and couples to make more substantial gifts. Where a gift is made to another individual it does not carry an immediate IHT charge. Provided the donor survives seven years from the date of making the gift, the gift will no longer be subject to Inheritance Tax.
Should the individual die within seven years of making the gift, the timing of the gift and the interaction with the donor’s nil rate band (currently £325,000) for IHT purposes needs to be considered.
As a potentially exempt transfer is exempt from IHT, provided the donor survives the gift by seven years, the nil rate band can effectively be utilised every seven years to make IHT free gifts of £325,000. In the case of a married couple £650,000 can be gifted every 7 years.
Lifetime giving can reduce your inheritance tax exposure
Lifetime giving should be one of the most straightforward ways of reducing an individual’s potential IHT exposure, however, the rules can be surprisingly complex with many pitfalls and traps, into which the ill-advised may fall easily, particularly when dealing with trusts.
For anyone seeking advice regarding the possibility of reducing their potential IHT exposure please contact the Private Client Tax Team at Wheelhouse Advisors Limited.