As property prices increase, more and more people are finding that they will be leaving an Inheritance Tax bill for their loved ones on their deaths. Inheritance Tax is payable at 40% on the value of an estate over the available allowances. How can you reduce your Inheritance Tax liability and make sure that your loved ones receive more of your estate?
One of the most efficient tax planning tools is to give assets away, either outright or into trust, to reduce your estate and the amount of tax payable on it. However, such measures require planning, and time, so don’t leave it too late.
Subject to a number of exceptions, any assets that you give away in the seven years before your death will be bought back into account when calculating the Inheritance Tax on your death. When outright gifts are made, these are known as ‘potentially exempt transfers’ (PETs). If you die within seven years of making a PET, it becomes a failed PET and is then a ‘chargeable transfer’. Where gifts made in the seven years prior to death exceed £325,000, tax will be payable by the person who received the gift. The tax on larger gifts will start to taper after three years, so even if you expect that you may not live for a further seven years, it could still be worth making such gifts and having the joy of seeing the recipient enjoy it. However, it is a common misconception that the gift itself tapers in value after three years. If the gifts amount to less than £325,000, these will simply reduce the tax free allowance that can be applied to the rest of the estate.
Some gifts are exempt from Inheritance Tax immediately. These include:
- Regular gifts made out of surplus income rather than capital.
It is important to keep accurate records of such gifts to assist your executors. For example, a high level of detail is required to prove that gifts out of income were indeed from surplus income and it is worth looking at HMRC’s form IHT403 to see the type of records that your executors will be expected to provide to claim this.
- Gifts of up to £3,000 per year (not per recipient)
- Gifts on the marriage of your child (up to £5,000) or grandchild (up to £2,500)
- Gifts to a spouse or charity
- Small gifts of up to £250 per year to an unlimited number of people per year.
Trusts can also be a useful way to reduce your estate and are often used to meet expenses such as school fees for grandchildren. Gifts into trust carry some additional rules and are subject to their own tax regime so advice should be sought. With the exception of trusts established for disabled people and bare trusts, assets in the trust do not form part of anyone’s estate for inheritance tax purposes but an inheritance tax charge may arise every ten years, as well as when assets leave the trust. Gifts into such trusts are always ‘chargeable transfers’ (unless the surplus income and annual £3,000 exemptions apply) and transfers into trust that exceeds £325,000 in any seven year period may face an immediate inheritance tax charge.
Subject to limited exceptions, it is important not to retain any benefit in any asset that you give away. If any benefit is retained then the asset will still be included in your estate for Inheritance Tax purposes at its market value at the date of your death. This would include giving away your home but still living there (unless you are giving away only part and are making the gift to somebody else who also lives in the same home, such as an adult child) or giving away a holiday home and still visiting (unless a full market rent is paid).
You may receive an inheritance from somebody who has died that you do not need and which will increase your estate unnecessarily. In that case, you could consider entering into a Deed of Variation within two years of that person’s death to redirect the inheritance to somebody else or to a trust. As long as the Deed contains the appropriate elections, there will be no Inheritance or Capital Gains Tax consequences for your estate and the gift will fall out of your estate immediately.
It is important to seek legal advice when making gifts for Inheritance Tax Planning purposes, particularly as other taxes, such as capital gains tax and stamp duty land tax, can also come into play when making gifts. It is a course that contains plenty of traps for the unwary but, if done correctly, and if you are lucky enough to outlive your gifts by seven years or fall into any exemptions, gifting could significantly reduce the inheritance tax bill left on your death. However, it is equally important to make sure you retain enough funds to live comfortably.
Give early, give often, but don’t give away more than you can afford.