Gifts to avoid Inheritance Tax
There are quite a wide range of gifts that can be made to reduce your Inheritance Tax liability while you are alive as they are classed as Exempt gifts. These gifts are different to Potentially Exempt Transfers in that they work immediately and there is no 7 year waiting period for them to become effective.
Inheritance Tax Gifts Exemptions
You could consider these as an effective, albeit limited, way to reduce your estate and therefore the eventual Inheritance Tax liability. However, these must be outright gifts and so you should ensure that they would not affect your income or security as you will forego the right to the income or capital in the future.
Annual Gift Exemption
- Annual £3,000 exemption – This exemption should be used by most people who have an Inheritance Tax problem provided the capital is liquid and not tied up in property. The amount is per person and so each spouse can make a gift of £3000 per financial year.
- Any part of this exemption not used in one year can be carried forward to the following year only. However, the later year’s exemption must be used completely before using the part, which has been carried forward.
- £3000 may not seem like a lot of money to some people but over 10 years it could add up to £60,000 and so save £24,000 in Inheritance Tax.
- Make sure the money does not come from capital or the 7 year rule will apply if its over £3000 a year. Other gifts over £3000 per year from capital made directly are Potentially exempt transfers which fall back into your estate if you do not survive 7 years after making the gift.
- Gifts from one spouse or civil partner to another are always immediately free of Inheritance tax. There is no limit as to the amount of the gift between spouses.
- Grandparents gifting Each grandparent has an allowance of £2,500 in consideration of marriages of grandchildren. In this case, if the gift is to be effective for inheritance tax purposes, it has to be made before the wedding and of course the wedding has to happen.
- Each parent has a gifting allowance of £5,000 in consideration of marriage of their children.
- It has to be gifted before the marriage and the marriage has to take place.
- All gifts to charities are immediatlt exempt from inheritance tax. The same occurs for gifts to charities in your Will.
- Gifts for national purposes, political parties, housing associations and certain transfers to employee trusts.
- You can give as many gifts of up to £250 per person as you want during the tax year as long as you have not used another exemption on the same person.
Gifts out of Normal Income
- This is a very under utilised allowance but are good for people who have a higher income than they use on a normal basis. These gifts must be regular and habitual and the intention to make them regular should be recorded in writing, signed and witnessed. The document should then be kept with your Will.
- Any income that is potentially taxable for income tax can be used including income from investments or property. Be careful as the funds must be from income and not capital.
- The regular gifts of income should also not affect your standard of living and so producing an income and expenditure breakdown is also useful in the event the gifts are challenged by HMRC.
How to keep a written record of all gifts made
It is important to keep a written record of all gifts made. If applicable, advise your accountants of them so that they can be correctly dealt with from a tax and reporting point of view. This will also ensure you should benefit from any available relief.
- Record your income and expenditure and keep bank statements and tax returns to prove the gifts are easily affordable and do not affect your normal standard of living.
- Do this annually to prove the money came from income. (Take care it’s not investment bond income as that is return of capital). Basically, its income if income tax is due on it.
- Document the reason and intention of the gift and specifically state it is not a loan.
- State it is to be made regularly (ideally monthly as the gift is immediately exempt) and have that document signed and witnessed and kept with your Will.
Gifts into Trusts
Gifts into trusts are classified as Chargeable lifetime transfers in that should the gift exceed £325,000, tax is immediately payable at 20%.
Do not make gifts into a trust without proper and experienced advice as merely making gifts in the wrong order can potentially cause an increased tax liability and certainly don’t make a gift of your main residence without taking good advice.