Insights

Inheritance tax is probably one of the most disliked taxes; charged at a rate of 40%, it tends to feel unfair to people who have spent years working hard to build up their estate, only to learn that HMRC is set to receive yet more significant taxes from assets which have been established out of taxed income. But that’s the unfortunate reality if you do not have an active inheritance tax planning strategy, such as lifetime giving, in place.

It can be difficult to avoid inheritance tax, simply because we all need to ensure we have enough assets for our future and of course planning for the future is uncertain; as a result, inheritance tax planning can seem overwhelming and is often ignored. There is an alternative however, to being overwhelmed by the big, uncertain picture, and this is embracing the many, sometimes seemingly small ways, in which future inheritance tax liabilities can be reduced over time. Taking action as early as possible, however small that action may be, can make a real difference and can provide you with the added pleasure of seeing the benefits your wealth can have on the lives of others.

This can of course be achieved by having an ongoing a strategy of lifetime giving in place.

Different types of lifetime giving for inheritance tax planning

Some lifetime gifts will fall outside your estate immediately they are made; some will only fall outside your estate provided you survive for 7 years, but they do receive a tapering relief, and so can reduce your inheritance tax exposure after 3 years; and some gifts will fall outside your estate after 2 years.

Over a number of years, a considered strategy can add up to a considerable inheritance tax saving.

Gifts that are immediately exempt from inheritance tax

The following gifts will leave your estate immediately the gift is made, with no need to survive for 7 years to reduce your inheritance tax liability:

1. Small gifts of up to £250 per tax year to any number of people;

2. Annual gifts of up to £3,000 per tax year. If you have not used this relief in the previous tax year, your unused allowance can be carried forward for one tax year only. Therefore, a couple is able to reduce their estate by £12,000 (£3,000 x2 x 2) in one tax year;

3. Gifts between a husband and wife or civil partners who are both domiciled in the UK. Note that where the transfer is from a party domiciled in the UK to a partner domiciled abroad, restrictions apply and advice should be sought;

4. A gift in consideration of marriage -a parent can give up to £5,000 to their child on marriage; a grandparent can give up to £2,500; and anyone else can give up to £1,000. This relief applies by individual, so a couple is able to give £10,000 jointly to their child on marriage. It is important that the gift is made before the wedding;

5. A very valuable and often overlooked relief - gifts from surplus income can be made in addition to capital gifts (e.g. from savings). Special conditions apply for these gifts to qualify, including the requirement that income gifts must come from post-tax surplus income, once normal deductions for living have been made. Income gifts must also be made regularly, for example through a standing order from a current account. Payments made to assist with living costs between spouses, or to finance the cost of maintenance and education or training for family members do not qualify.

Two aspects of gifting from surplus income to be aware of are that firstly, they must not reduce your normal standard of living, i.e. if you usually take an expensive holiday and then can no longer afford to because you make gifts out of income, this could impact their future tax treatment.

Secondly, these types of gifts are difficult to prove retrospectively without documentation already being in place declaring the intentions of the donor to make income gifts. It is usual that such exemption claims have to be made by the executors of an estate and it is important for them to have records available of your intentions for discussion with HMRC, if needed.

6. Gifts to charities can always be made without incurring inheritance tax, regardless of whether income or capital is given. For people with large estates, there are additional benefits to gifting part of your estate to charity in your will. If you gift 10% or more of your estate to a charity upon death, this will reduce the rate at which inheritance tax is payable on the remainder of your estate to 36%. For this reason, many people prefer to delay charitable gifts in order to secure the lower inheritance tax rate.

Gifts that may be inheritance tax free depending on timings

Other gifts you make to individuals during your lifetime are classified as ‘potentially exempt transfers’ (PETs). There is no inheritance tax to pay when the gift is made and it can potentially be exempt from inheritance tax, if you survive for seven years after making the gift.

However, if you die within seven years of the gift, the PET status is reassessed and inheritance tax will be payable in varying amounts depending on the availability of ‘taper relief’.

Table showing how taper relief can reduce tax due on PETs:

Note that gifts into trust are not PETs and different rules apply to these, therefore advice should be taken before making such gifts.

Finally, if you wish to make gifts that will fall outside your estate more quickly than 7 years, you may want to consider making gifts of assets that qualify for business property relief or agricultural property relief; these can be exempt from inheritance tax after two years. Complex rules apply and advice should be taken.

If you would like to discuss inheritance tax planning and lifetime giving in more detail, please contact Lesley Stalker by emailing las@rjp.co.uk