Inheritance tax planning through gifting

Inheritance tax (IHT) becomes a concern when your estate's value exceeds £325,000 threshold, or £650,000 for couples. Proactive estate planning through gifting during your lifetime can significantly reduce IHT liabilities. Inheritance tax (IHT) is a complex area and there are different exemptions applicable to different individuals. For example, pensions and business assets do not usually form part of the estate for IHT calculations. Everybody is entitled to a nil rate band , which means there is no IHT to pay on the first £325,00 of assets. In some circumstances, an additional residents nil rate band can be applied to the main residence. However, this blog will look at some of the ways gifting early on can be used to reduce the IHT liability on death.  

Gifts 

£3,000 Annual Exemption: Every year, you can give away £3,000, and this gift won't be added back into your estate for tax purposes when you die. If you didn't use this exemption last year, you could carry it forward one year, giving you up to £6,000 that you could give away tax-free. 

Gifting from Excess Income: If you have income that you don't need for your regular living costs, you can use this extra money to make gifts. These gifts won't be considered for inheritance tax, as long as you're giving away income that you genuinely don't need and you make these gifts regularly. This could include, for example, giving money to your children or grandchildren every year to help with their expenses. 

When considering significant asset transfers, timing is crucial. Gifts to non-spousal beneficiaries should be planned with the potential seven-year timeline in mind. These 'potentially exempt transfers' become fully exempt from IHT if you survive more than seven years after making the gift. However, should you pass away within this period, the gifted amount may still be considered part of your estate and be liable for IHT.  

Concerns around making outright gifts 

Directly transferring wealth can raise various concerns. For instance, if beneficiaries face personal or financial instability, there's a risk of gifted assets being squandered or claimed by creditors. Moreover, in the event of a beneficiary's divorce, there's a possibility that the gifted assets could be considered in the divorce settlement. 

In addition, if you give something away but still enjoy its benefits (like living in a house you've given away), it's still considered part of your estate and could be taxed when you die. So, it's important to plan these gifts carefully and perhaps seek advice to ensure they're done correctly. 

The Role of Trusts in Estate Planning 

Trusts are a way to look after your assets when you're no longer here, giving you control over who benefits from them and how. They can sometimes help reduce inheritance tax (IHT) that needs to be paid, but can be complex.  

When you create a trust, you decide its rules and who will manage it (the trustees) after your death. These trustees then have a legal duty to look after the assets for the people you've chosen to benefit (the beneficiaries). 

Gifts into certain types of trusts attract an immediate charge to inheritance tax, but only to the extent that the value of those gifts exceeds the nil rate band (presently £325,000). The nil rate band replenishes itself every seven years. This means that it is possible to transfer significant value away from the estate during lifetime, by making regular seven-yearly gifts of the nil rate band allowance into trust. Both spouses can make use of their respective nil rate bands so £650,000 can be put into trust by a couple every seven years. 

If the amount put into the trust does exceed £325,000, there will be an immediate tax charge of 20% on the excess. Furthermore, there will be a tax charge at 10 year intervals on the excess over the nil rate band. Again, this can be complex so good planning is advised. 

Preserving Access and Control 

It is understandable that some people may be reluctant to fully give up access to the funds, but there are options to maintain access to the capital or an income from the amount gifted into a trust: 

Loan Trusts 

By placing capital into a loan trust, you maintain access to your funds, withdrawing as needed. While the loaned amount remains in your taxable estate, any investment growth within the trust does not, offering a balanced approach to accessibility and tax efficiency. This setup is great for those cautious about locking away their savings but still eager to plan for the future. 

Gift Trust 

Opting for a discounted gift trust enables you to reduce your estate's taxable value while receiving lifelong, fixed payments. Such arrangements distinguish between the gifted amount and your retained benefits, aligning with IHT efficiency. You get a steady stream of payments for as long as you live and after you pass away, whatever is in the trust then goes to your beneficiaries. 

Balancing Enjoyment and Legacy 

Amid planning for the future, it's paramount to enjoy the present. While asset-rich individuals might contemplate extensive gifting, it's essential to balance this with personal fulfilment. Leveraging assets for memorable experiences should not be overshadowed by estate planning.  

However, once personal aspirations are met, thoughtful estate planning can ensure that your legacy benefits your loved ones with minimal IHT impact. Early and informed planning can maximise asset transfer to beneficiaries while adhering to legal frameworks and tax efficiency.