Lifetime gifts which qualify as part of your normal expenditure out of surplus income are wholly exempt from Inheritance Tax (IHT).
So, making gifts during your lifetime can be an effective way of reducing your estate’s exposure to IHT if you have surplus income and wish to establish a regular pattern of giving for your intended eventual beneficiaries.
With IHT being charged at 40% on estates over £325,000, making use of surplus income gifting allows you to offer financial support while making your estate more tax efficient.
More people are looking to mitigate their IHT in this way, especially given that the exemptions for other lifetime gifts have not increased for very many years and the annual IHT exemption is unchanged since 1981!
What is surplus income?
Surplus income is any income left over once all your outgoings have been paid. Income includes:
- Employment income & pensions
- Dividend income, interest, ISA’s
- Rental Income
- Income received from a trust
Be aware that the tax free, 5% annual withdrawals from an investment bond are not counted as income for this purpose.
For your gifts to be exempt from IHT they must be following these three rules:
- The gift must be part of your normal (i.e. typical or habitual) expenditure; and
- The gift must be made from your after-tax income, taking one year with another; and
- After allowing for all other transfers of value forming part of your expenditure, you are left with sufficient income to maintain your usual standard of living.
What next?
Establishing a regular payment schedule with your bank is the standard next step if you can afford to give money on a regular basis without it interfering with your everyday lifestyle.
It’s worth noting that there is no legislated minimum number of gifts or period over which gifts must be made.
It is important to take precautions to help your giftee when dealing with your IHT liability after you pass. Maintaining good quality documentation is key and the following would be useful evidence for them to present to HMRC:
- A file of all payments and your income history.
- A written letter of intent to your giftee, outlining that the gifts are being made from surplus income.
Trying to retrospectively reconcile seven years’ worth of income, spending and gifting can be challenging for beneficiaries and executors.
What about couples?
Where one spouse has a level of income less than their share of the expenses, it is presumed that the other spouse subsidises them, so it is sensible to assume that they cannot make any gifts which would be subject to the IHT exemption.
Therefore, in the case of gifts out of surplus income their tax is treated as akin to joint taxation.
If you are in a position where you have regular income left over after covering all your day-to-day needs, and you want to explore if you can mitigate your IHT exposure, get in touch to discuss how we can help. Email enquiries@cowgills.co.uk
