Cash or other financial gifts might be more welcome than ever this Christmas. In grim economic times, older savers with some accumulated wealth might decide that some of their hard-earned assets should be transferred to younger generations now – rather than deferring their generosity until the reading of a will.
The good news is that, done properly, this can go some way to reducing or negating inheritance tax liability, thereby increasing the benefit to all concerned. Ian Dyall, Head of Estate Planning at leading UK wealth management firm Evelyn Partners, says that this imperative is becoming relevant to more and more families as an increasing number of estates are dragged into the IHT net by asset price inflation and the frozen nil-rate bands.
This allowance deep freeze was extended to the 2027/28 tax year in the Autumn Statement – and the Office for Budget Responsibility expects that IHT receipts to soar 28% as a result, from £6.1billion in 2021/22 to £7.8billion in 2027/28.
‘Sharing wealth and helping loved ones financially is becoming even more of a priority as demands mount on the budgets of young families,’ says Dyall. ‘Passing on wealth during their lifetime also rewards the giver with the satisfaction of seeing the benefits being enjoyed. While it can in addition bring tax advantages, lack of familiarity with the rules could also be punished with tax penalties.’
At Christmas, the majority of casual monetary gifts will fall within the HM Revenue & Custom’s allowable limits. But more generous or ongoing transfers can cause tax issues for the recipient, so in this case some planning is advisable.
Dyall adds: ‘As accumulators of wealth decide to pass on larger amounts during lifetime, whether this is announced as a festive gift or not, more care is required to make sure the Treasury doesn’t get an IHT present further down the line.’
The tax rules for financial gifts
There are some basic transfers that are tax-free:
· Gifts up to any value between UK domiciled spouses and civil partners are free from tax.
· Gifts for the National Benefit, such as gifts to museums and libraries etc, are all free from tax too.
· Gifts to Charity of any value are also free from tax and may even qualify you for an element of income tax relief through Gift Aid.
Gifts to individuals that do not fall within the above categories might also be untaxable as long as they meet the following conditions:
· Total gifts made by you in a tax year total less than £3,000. You can also carry forward any unused £3,000 allowance from the previous tax-year, making financial gifts of up to £6,000 possible this Christmas
· Small gifts of up to £250 can be made to any number of people in the tax year, provided the total to any one person does not exceed £250. If it does, this exemption does not apply and all gifts would start to use up the aforementioned £3,000 allowance
· Gifts out of regular income that are part of normal ongoing expenditure can also be made (see below for more detail)
· Money can also be given as a gift tax free in the event of a marriage or civil partnership amounting to £5,000 from each parent, £2,500 from each grandparent and up to £1,000 from any other person. These would not use up any of the other allowances
What happens if you breach any of these limits?
Larger gifts can obviously be made – and without issue as long as the donor then survives for seven years, during which time such gifts remain ‘potentially exempt transfers’. If the donor dies within seven years, the nil-rate band is reduced by the value of the gifts (so in a sense they are counted as never having left the estate), and tax on assets above the NRB will be due at up to 40%.
We say ‘up to’ because if the gifts put together exceeded the nil rate band then taper relief can apply, which reduces the tax paid on older gifts. If there were three-to-four years between date of gift and death, the IHT rate lowers to 32%, while at six-to-seven years the rate falls to just 8%.
All of which means that large gifts exceeding the nil rate band can moderate IHT liability even if they fall foul of the seven-year rule. If a gift does become liable for IHT, it is the recipient who will have to pay, and they may not have the resources to meet a surprise tax bill when it arrives, possibly having spent the money.
A corollary of all this is, that if someone makes a gift of a value below the nil-rate band to one person, and then dies within seven years, then all the beneficiaries of the estate could share the liability on the lifetime gift received by one person.
The only time, in the main, that a donor will be subject to tax upon a gift during their lifetime would be if they made a gift to a discretionary trust, over the donor’s available Inheritance Tax nil rate band.
Gifts with reservation – and capital gains tax
If a donor gives something but continues to receive a benefit from it – such as a house where they continue to reside – the donor isn’t liable in the sense that they will need to pay a tax bill during their lifetime. A ‘gift with reservation’ simply remains part of the estate for inheritance tax purposes, so the executors might need to pay more tax on the estate.
But it is worth remembering that for the purpose of other taxes like capital gains tax, the gift IS effective, which could create a ‘worst of both worlds’ situation. For example, if you gift your home to your child but live in it without paying a market rent, the gift is ineffective for IHT relief, so IHT will still be paid on it on death. However, for CGT purposes, the property does belong to the recipient, but if they don’t live there – or if they had already owned a home – there would probably be no exemption for main residence relief when it is sold on any capital gains since they received it.
Donors considering such steps would be well served by some specialist tax advice as these are complex areas.
Gifting from surplus income
Many donors like to give ongoing regular amounts, to young relatives for instance, into a savings or investment vehicle – such as a Junior ISA, pension or trusts. But to be IHT-efficient, regular gifts must meet certain rules.
What is surplus income?
Surplus income is what remains after all of your outgoings have been paid: funds left over which are surplus to needs and have no bearing on your standard of living. Your income includes earnings from employment and pensions, but it can also include interest, dividends and rental income. But some regular payments which savers might think of as ‘income’ are not counted.
Two of the most common examples of this are regular withdrawals taken from a life assurance bond and if you have a purchased life annuity (i.e. it was not purchased with pension funds and was bought through other sources). Only part of the annuity will be considered as income and the remainder will be a return of your invested capital, as will all the withdrawals made from life assurance bonds.
How do I make regular financial gifts?
It can be as simple as setting up a regular standing order directly into the recipient’s bank account. Alternatively, you might want to set up some sort of policy for the recipient, such as a life insurance or pension plan, and you could pay the regular premiums out of your surplus income.
Parents or grandparents can pay into a JISA, an early-years pension or a trust to house accumulated regular gifts for their offspring.
The inheritance tax outcome
The ‘normal expenditure out of income’ exemption will apply even if you die within seven years of the last gift, as long as three key rules are met:
· The gifts must be made out of your income
· They form a part of your ‘normal expenditure’ and are paid out on a regular basis
· The payments should not have any impact on your own standard of living
Then the gifts will be exempt from IHT and neither the recipients nor the estate will pay tax on these gifts.
Normal expenditure can be a grey and difficult area, and a possible source of dispute with HMRC when executors come to deal an IHT liability. The best policy for a donor is to set out their intentions around regular gifting and to keep clear paperwork recording the gifts, alongside their overall income and expenditure.
The use of trusts – and bare trust vs JISA
Many older savers want to transfer wealth during their lifetime but prefer to retain some access or control over the assets. For this purpose two types of trust are of particular interest.
A discretionary trust can allay some concerns that a beneficiary might squander assets, or lose them through divorce or a business insolvency – or simply to limit access until a child is of age. The beneficiary will be listed as one of several possible beneficiaries and will only benefit at the trustees’ discretion, so the trust can protect the assets, and the timing and size of any payments made from the trust can be controlled. Each person can gift up to the £325,000 nil rate band into discretionary trusts in any seven-year period without triggering an IHT liability. Gifts exceeding this will be immediately liable to IHT at 20% with further tax due if they die within seven years.
A bare trust can also be useful, particularly where grandparents wish to invest for grandchildren. When investing for minor beneficiaries, the natural instinct is to use tax-beneficial wrappers such as a Junior ISA, but these are limited in size and can’t be accessed before age 18, even for the child’s benefit. If a grandparent invests for a grandchild using a bare trust, the invested amount is unlimited and money from the trust can be used for the child’s benefit before 18 if required. The investments are taxable, but it is the minor beneficiary who is liable, and their personal income tax and capital gains tax allowances usually eliminate any liability.