For some people, time spent at home during lockdown has provided an opportunity to save more money as holidays, eating out and commuting costs have all been put on ice.
If you have a bit more money in your bank account, it’s a good time to think about inheritance tax (IHT) and the financial benefits of giving away assets while you are still alive to reduce the size of your estate.
Here, Kim Carr, Lead Partner of the Wills, Probate & Lifetime Planning team at FBC Manby Bowdler looks at the rules around inheritance tax, gifts and surplus income, and how you can reduce the tax burden on your loved ones in the future, today.
IHT rules state that when you die each person can pass on a maximum of £325,000 in assets tax free, including shares and property, and there is an extra £175,000 allowance when the main home passes to a direct descendant. If someone is in a marriage or civil partnership, they can leave everything free of IHT to their partner and when the second partner dies, generally the two allowances are added together when calculating whether tax is due on the combined value of the estate.
But it’s worth knowing that while alive, anyone can make gifts from their asset base, whether to those who will inherit when they die, or to other family, friends or charities they wish to support during their lifetime. Making these gifts can help reduce the value of the estate and the tax due, if some simple rules are followed.
Broadly speaking, gifts come under two headings: those where the allowance is automatic if the gift fits the rules, and those where the exemption must be claimed after death, such as gifts out of surplus income.
Surplus income is what remains after you have maintained your normal standard of living and all your usual expenditure, without tapping into any savings or other retained assets.
A gift will only qualify for this exemption if it is part of a regular pattern of giving and you can demonstrate that it came from surplus, current income. If time elapses and income is effectively moved to savings, then it is unlikely to fit the criteria.
If you have surplus income that has built up during the lifestyle restrictions of the past year, it’s a good idea to review this swiftly, while it is still current income. To make such gifts, it is essential you record your intention in writing, and then keep a simple record of income and outgoings during the year, for example by taking the figures from your bank statements.
Here’s why record-keeping is so important: the exemption for gifts from surplus income must be claimed after death by the executors of a person’s will because they are not given automatically. The executors must be able to demonstrate that the criteria for the exemption – i.e. that the gifts were made out of surplus income and that you were able to maintain your normal lifestyle – have been met.
When gifts are made to an individual out of capital, rather than income, they are known as potentially exempt transfers because they drop out of account and become wholly exempt if you live for seven years after the date of the gift. If you die within that seven-year period, the value of the gift must be brought into account in working out the IHT payable by the estate.
Alongside these potentially exempt gifts, there are some automatic allowances. These include an annual exemption of gifting of up to £3,000, together with a separate small gifts allowance of up to £250 per person.
The annual exemption of £3,000 can be gifted as a single sum to one person or divided among many. It can also be carried forward one year but cannot be combined with the small gift allowance. The small gift allowance allows any number of gifts of up to £250 per recipient, as long as no individual receives more than £250.
Gifts to charities and political parties are exempt and when you die the IHT rate on your estate will be cut from 40% to 36%, if you are leaving at least 10% of your net estate to charity.
But whether you are dealing with automatic allowances, surplus income or other potentially exempt transfers, it’s advisable to track all gifts as it will make it much easier when your executors have to deal with HMRC later.
You should also make gifting part of a regular, annual review of your finances because the rules can change and it also acts as a prompt to keep your record-keeping up to date. It’s also important to review your will if you have made any significant gifts to check how they might be affected.
Want to know more about your inheritance tax relief options? Get in touch with Kim Carr on 01902 392427 or email firstname.lastname@example.org for guidance on the rules to ensure your loved ones, friends and the charitable causes you support receive more of the gifts and assets you bequeath to them.