Is your prospective inheritance tax liability on your mind? Understandably, you no doubt want your family or other beneficiaries to inherit everything that you’ve worked hard for, and not the tax man. If so, Christmas is an excellent time to think about making gifts of certain specific amounts, in order to do some straightforward inheritance tax planning.
In very broad-brush terms, currently any individual leaving their house to their children, with an estate worth over £500,000, or couple leaving their house to their children with a joint estate worth over £1,000,000 will pay inheritance tax at 40% on the balance, on death. There are a number of inheritance tax allowances and exemptions which are available to everyone, each tax year. Using them annually can be a good way to chip away at a prospective inheritance tax liability. Done properly, this type of planning is completely acceptable to HM Revenue & Customs.
Inheritance Tax was once famously described by the late Lord Jenkins of Hillhead, former Home Secretary, as “A voluntary tax, paid by those who distrust their heirs more than they dislike the Inland Revenue.”
From an (often sceptical!) donor’s point of view, the beauty of starting to allow a very gradual transfer of wealth by using your allowances and exemptions regularly is that it allows you to test the waters in terms of your heirs’ ability to manage money responsibly, before transferring larger sums.
By way of reminder, the following allowances and exemptions are available:
Annual Exemption – £3,000 per person
Each person can give away their ‘annual exemption’ of £3,000 per tax year, completely free of inheritance tax. If you are a couple, you can therefore give your children (or other beneficiaries) up to £6,000, inheritance tax free. You can carry forward any unused annual exemption to the next year, but for one year only.
Small Gifts – £250 per person
You can also give away ‘small gifts’ of up to £250 per person per tax year, to as many people as you like. (This exemption cannot be added to the £3,000 annual exemption to make a gift of £3,250 to one person, though.)
Normal Expenditure out of Income
There is an exemption for ‘normal gifts out of income’. This means that you can regularly give away as much income as you like, as long as you are able to maintain your usual standard of living after making the gifts. This type of gift needs to be carefully documented, in case it is ever challenged, but the exemption can be extremely valuable for the right client. If you are at a stage in your life when you have a lot of income, some of which you don’t need, and you also have a prospective inheritance tax problem, then this is for you.
It is important to record not only the gifts, when they are made and to whom, but also your income and expenditure during the period when you are making them. This will mean that, if the gifts were ever challenged, your executors would be able to prove that the income being used to make the gifts was indeed ‘excess’, and unnecessary to maintain your usual standard of living.
Gifts in Contemplation of Marriage
If a loved one is getting married, you can give inheritance tax free wedding gifts of £5,000 per child, £2,500 per grandchild or great grandchild and £1,000 to anyone else (HMRC apparently thoroughly disagreeing that you ‘can’t put a price on love’.)
Potentially Exempt Transfers
You can make larger gifts up to your inheritance tax free nil rate band of £325,000 per person, free of inheritance tax. This type of gift is known as a Potentially Exempt Transfer or PET, because if you survive the gift by 7 years, it will fall out of account in your estate for inheritance tax purposes. However, in the meantime it will use up your nil rate band, which would then be reduced accordingly, if you died within 7 years. Alternatively, the money could be passed to a lifetime trust for the benefit of family members without an immediate tax charge, if you would prefer your beneficiaries not to inherit outright as yet.
Substantial sums can be removed from an estate this way, if the gifts are made over a number of years, especially if it is possible to start when a client is say only in their 50s or 60s, so youngish in inheritance tax planning terms (flatteringly, your inheritance tax adviser will think of you as ‘young’ for an awful lot longer than would be the case in say modelling, or professional football).
Gifts to Charities or Political Parties
Finally, gifts of any amount that you might want to make to registered charities or (try not to laugh) political parties are free of inheritance tax.