Beware Inheritance Tax when making Gifts.
5th July 2019
Beware Inheritance Tax when making Gifts.
A recent study* highlighted that only one in four people making financial gifts were aware that these may form part of their estate for Inheritance Tax. Further to this, only 8% of respondents considered tax rules before making a financial gift and most did not associate gifting with Inheritance Tax. With over half of respondents saying that they planned to leave inheritance, it’s obvious that there is a gap in knowledge concerning this matter.
When you consider that the highest proportion of gifts (around 80%) were made to individuals, with the most common beneficiaries being adult children, it is clear that any mistakes could mean that the gift could become an issue for the family
So, what are the Inheritance Tax rules when it comes to making Gifts.
All gifts and transfers of assets between spouses and civil partners are exempt as long as your spouse or civil partner lives in the UK on a permanent basis. Alongside that, everybody has an annual gift exemption. This is currently £3,000 and means you can give this much away per year, free of Inheritance Tax. Whilst this allowance is per person and NOT per gift, you can carry forward the allowance from the previous year if you didn’t use it.
On top of that, an individual can make a gift of up to £250 per person and they will be deemed as Inheritance Tax free (This only counts for when you haven’t given the same person a gift under another tax-free allowance). There are also further allowances for marriage or civil partnership. These are a maximum of £1,000 per person, but increases to £2,500 for grandchildren and £5,000 for children. Do note that gifts must be given close to the date of the ceremony in order to qualify.
There is a typically vague rule from HMRC which states that gifts made out of your income, e.g. Christmas or Birthday gifts, are exempt from Inheritance Tax. This rule applies as long as you are left with adequate income to maintain your standard of living after making the gift. The gifts should be seen to be regular and come from income, not savings. Of course, there is nothing to stop you from paying for your children’s holiday or school fees for grandchildren.
Any further gifts are considered as Potentially Exempt Transfer and will only fall outside of your estate for Inheritance Tax as long the donor survives seven years. This is not the case when it comes to transactions with a reservation of benefit. For example, if you give away your home to your children and continue to occupy it rent-free, the property is still considered as forming part of your estate on death.
To help your Executors manage this situation, it is crucial that some form of ‘Gift Log’ is put in place to ensure that they have an adequate record of any gifts made in the previous seven years (as it is the Executors who will be responsible for any Inheritance Tax payment). This should log the date and amount of gift made and what the gift was for. The Log itself should be kept with your Will so that it is easy to find. This is to ensure that any challenge made by HMRC concerning payments made from your estate can be allocated accordingly without the need for your Executors to trawl through seven years of bank or credit card statements.
Gifts to Charities that are registered in the UK are exempt from Inheritance Tax. Furthermore, if 10% of your estate is left to Charity on your death, the IHT rate reduces to 36%. For larger estates, this could be a substantial saving and should be considered. However, we would suggest this is something that needs to be discussed in detail with your beneficiaries and also needs to be managed and worded carefully to ensure all parties benefit fully from this.
Though it may be uncomfortable to plan for the worst, knowing how to best mitigate the tax surrounding gifts and inheritance can help you make key financial decisions at the most opportune moments, and prevent any avoidable losses when it comes to sharing your assets with the people and organisations that matter most to you.
If you are considering making gifts, or have done so recently, we would urge you to contact us so we can discuss the best course of action.
*Study conducted by the National Centre for Social Research (NCSR) and the Institute for Fiscal Studies (IFS)