Inheritance Tax – gift planning strategies
Gifting assets during your lifetime can be an effective way to reduce your IHT liability. We look at the rules and the pitfalls.
Inheritance Tax (IHT) is often described as a 'voluntary tax' because careful planning can significantly reduce the amount payable. One of the most common strategies is making lifetime gifts.
Most gifts are 'potentially exempt transfers' (PETs), meaning they become entirely tax-free if you survive for seven years after making the gift. You also have an annual gift allowance of £3,000, and small gifts of up to £250 per person are exempt. However, it is vital to keep detailed records and understand the 'gift with reservation of benefit' rules to ensure your planning is effective.
The seven-year rule
When you make a significant gift to an individual, it is classed as a PET. If you live for seven years after making the gift, it falls outside your estate entirely for IHT purposes. If you die within seven years, the gift is added back to your estate. However, if you die between three and seven years after making the gift, 'taper relief' may apply, reducing the rate of tax payable on the gift itself (though it does not reduce the value of the gift added back to the estate).
Gifts out of normal expenditure
One of the most powerful, yet underused, IHT exemptions is 'gifts out of normal expenditure'. If you make regular gifts out of your surplus income (not capital), and making those gifts does not reduce your standard of living, they are immediately exempt from IHT, with no seven-year waiting period. This is highly effective for paying grandchildren's school fees or funding life insurance premiums. Detailed record-keeping of your income and expenditure is essential to claim this relief successfully.
Gifts with reservation of benefit
A common trap in IHT planning is the 'gift with reservation of benefit' rule. You cannot give away an asset but continue to enjoy the use of it. For example, if you give your house to your children but continue to live there rent-free, HMRC will treat the house as still belonging to your estate when you die. To avoid this, you must either move out or pay a full market rent to your children for your continued occupation.
Disclaimer
The information contained in this article is for general guidance on matters of interest only. It should not be used as a substitute for consultation with professional accounting, tax, legal, or other competent advisers. Before making any decision or taking any action, you should consult a Kingscott Dix professional.