Welcome to our new Ask Octopus column, written by Tax Product Specialist at Octopus Investments, Toyin Oyeneyin. This is where, each quarter, we will tackle some of the more complex estate and tax planning questions that advisers are asking. Consider this your advice support column for all your estate planning queries!
Our first adviser question is: How effective is gifting as an estate planning strategy? More specifically, I have questions around loss of access and how the gifting out of surplus income exemption rule works?
Toyin’s answer: Gifting can be an attractive estate planning option because your clients can see their loved ones benefit from their wealth whilst they’re alive.
In principle, it is a straightforward concept however, in practice, the rules around making a gift can be rather complex, and the effectiveness of them rests on some key points:
- Be bold and use as much as you can in exemptions and allowances.
- This can range from making full use of spousal and charitable gifts, wedding gift allowances, small gift allowances and the annual gifting allowance of up to £3,000 in total each year. These types of gifts attract immediate exemptions from Inheritance Tax (IHT).
- As for larger, non-regular gifts, they typically take seven years to become completely free from IHT (hence the name, potentially exempt transfers, or “PETs”). This means that if your client dies within seven years of making a PET, they are unlikely to have been effective in reducing the inheritance tax bill due on their estate. So, it’s worth considering the age and health of the individual making such gifts.
- And of course, regular gifts out of income rules are an opportunity to make certain gifts free from IHT.
2. Have precision in the timing of gifts:
- It serves to remember that certain gifting allowances are only per tax year, so timing is key. Your clients should look at whether it is worth delaying or accelerating such gifts to meet their goals.
- The timings of when larger gifts are made is also important for your clients to bear in mind. For example, with PETs or transfers into trust which could give rise to a chargeable lifetime transfer (CLT), the amount of IHT due on death can be different depending on whether the PET was before, or after, the CLT.
3. Accept the impact of not letting go:
- To your question on the implications of loss of access, it’s worth being aware that when making gifts, changing your mind can be difficult. Anyone making a gift loses ownership and control of that wealth as soon as the gift is made for it to be a true gift. If not, it is ineffective for IHT and still treated as part of your client’s estate under the gift with reservation rules.
- If access and control is a consideration, trusts can be used as a way of gifting away assets while keeping some level of control. However, this could give rise to IHT charges at the time of transfer and if death occurs within seven years.
- Something else to consider here is Business Relief (BR), particularly if you have clients comfortable with high-risk investments. BR investments can provide access and control while providing relief from IHT in just two years. However, should the client still want to subsequently take on a gifting strategy, they can with BR. Unlike non-BR qualifying gifts, a BR gift can still provide relief from IHT even if they die within 7 years and even if the gift is to a trust.
As to your second question around gifts out of surplus income exemption, there’s a few aspects to this we know advisers find themselves unsure on. For example, what income counts? How often and long do the gifts have to be paid for or what would happen if the client stopped the gifting?
The overarching point to cover off here is that gifts can be exempt from IHT where they are made as part of the normal expenditure, are made out of income (not capital), and the taxpayer is left with sufficient income to maintain their standard of living.
The legislation around this is not prescriptive on what is income for these purposes, the amount of gift, how many gifts, or how long such gifts need to be paid for them to be exempt.
However, HMRC guidance says there are a few things to consider:
- Income can include a variety of source including employment/self-employment, pensions, interest, rental income, dividends. They also explain that income accumulated from earlier years does retain its character up to a certain point, after which it then becomes capital. Although sadly there is no set rule on when this point happens.
- “Normal” expenditure/giving for one person is not the same for another. It does not necessarily mean annually. This means it will be highly dependent on the particular taxpayer or case. What is key in HMRC’s view is that there is a pattern or expected pattern of giving.
- HMRC do explicitly say that there is no set time span over which a taxpayer needs to show a pattern of giving. They provide an example that 3-4 years could be a reasonable period. But they caveat again that this is based on the set of circumstances and the particular taxpayer. And the period could be longer or shorter. Particularly as they also give an example that even a single gift could qualify if it was intended to be the first of a pattern of giving.
- If your client chooses to stop gifting, it does not mean the previous gifts would be taxable. The point here is still that HMRC will consider where there was a pattern/expected pattern of gifting, to assess which gifts should be exempt.
Hopefully that helps and I look forward to tackling more adviser queries around estate planning in the next quarter. If you can’t wait until then, or would like to understand some of the nuances of gifting strategies please use our free helpdesk to Ask Octopus.
Toyin Oyeneyin
Toyin is the Tax Specialist and Product Manager for Octopus Investments, being the technical lead across all their tax products. She has been with Octopus for over five years having joined Octopus from her previous role as a Senior Manager in M&A tax at PricewaterhouseCoopers. She is a Chartered Tax Adviser and a council member of the Association of Tax Technicians. She has 20 years’ experience across professional practice and industry, accounting, tax and finance.
