We are often asked for ways for client to make gifts that will not affect their Inheritance Tax (IHT) ‘Nil Rate Band’ so we have put together this short guide to explain the different types of IHT exempt gifts.
Annual gift allowance of £3,000
You can give away £3,000 worth of gifts each tax year (6 April to 5 April) without them being added to the value of your estate. This is known as your ‘annual exemption’.
You can carry any unused annual exemption forward to the next year - but only for one year.
Each tax year, you can also give away:
- wedding or civil ceremony gifts of up to £1,000 per person (£2,500 for a grandchild or great-grandchild, £5,000 for a child)
- normal gifts out of your income, for example Christmas or birthday presents - you must be able to maintain your standard of living after making the gift (see below)
- payments to help with another person’s living costs, such as an elderly relative or a child under 18
- gifts to charities and political parties
You can use more than one of these exemptions on the same person - for example, you could give your grandchild gifts for her birthday and wedding in the same tax year.
Small gifts up to £250
You can give as many gifts of up to £250 per person as you want during the tax year as long as you haven’t used another exemption on the same person.
You can make larger gifts however you should always be aware of the 7 year rule.
NORMAL EXPENDITURE OUT OF INCOME
This is slightly more complex and requires careful consideration and recording. If you have an accountant they maybe able to help you with this.
In brief you make or start to make a series of regular gifts out of your taxed income.
As long as you can satisfy the conditions they are exempt from IHT as soon as you make them and do not “eat” into your Nil Rate Band. If your circumstances change you can stop making them and it will not lose any exempt status.
The gifts can be made outright or into an insurance policy written in trust for the family. If you choose the Insurance Policy, the proceeds themselves, as long as you have placed these in trust, will also be exempt from IHT on your death.
If the amounts that you wish to make are sufficient large it may be worth creating a lifetime settlement. We can discuss this with you further if this is the case.
The conditions for these gifts to work that must be met are
- The gifts must be part of your "normal expenditure"
- "Normal" is not defined but there must be a prior commitment to make the gifts, or it must be shown (after the event) that the gifts were part of a settled pattern of giving
- The Courts have talked about the taxpayer having "assumed a commitment or adopted a firm resolution regarding their future expenditure" and then having complied with that. The commitment may be "legal, religious or moral."
- There should be evidence of an intention to make regular gifts over a period of time. This can be shown, for example, by a letter stating the intention to make the gifts, or a pattern such as the payment of annual premiums on a life policy for the benefit of someone else.
- There is no timespan over which the taxpayer must show a habit of giving, HMRC guidance suggests that "a reasonable time span would normally be three to four years."
- It is not enough to set money aside (say, in a bank account) with the intention of using it later to pay regular gifts to your chosen beneficiaries. It is essential to start the regular payments. If you do set aside a sum of money for the purpose of making the regular gifts, it is the payments you actually make which will qualify as normal expenditure, not the money you still retain.
- The gifts do not have to be made to the same person or always be of the same amount but a pattern must be established by proving a prior intention to make regular gifts, or showing that there was a pattern.
- The gifts must be made out of income
- "Income" means net income after tax. It would include salary, commissions or rent received, dividend income from shares, and interest paid on a bank or building society account.
- Gifts will not normally satisfy this condition if they are made from a source which was originally income, but has acquired the nature of capital because it has been retained or accumulated over a period of time.
- You are left with sufficient income to maintain your normal standard of living
- This is tested according to your own standard of living and not the standard of living of the 'average' person.
Things to remember
- The exemption is not given automatically and is claimed retrospectively by your Executors after your death. The Executors have to demonstrate to HMRC that your gifts satisfied the conditions set out above.
- The Executors need to complete a special form to demonstrate that the deceased person had satisfied the conditions for the exemption to apply. This form breaks down your income, living expenses and gifts year by year to show that you were indeed paying the gifts out of your income, and you had enough to maintain your usual standard of living. If you intend to make gifts which will utilise the exemption then it will assist your executors if you keep cash flow records which demonstrate your available income, year on year. This will save your executors having to carry out this exercise retrospectively.
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