Large gifts are a long-established method of reducing Inheritance Tax (IHT). However, not everyone can afford to, or wants to, give lump sums of money away. When given, large gifts are Potentially Exempt Transfers (PETs), which means that they are not completely IHT-free unless the donor lives for a further seven years.
The gifts from income rules is often overlooked.
However, it is a valid alternative to giving money away to reduce IHT, as transfers are immediately considered to be outside of the donor’s estate; and are thus potentially more IHT efficient.
What are gifts from income?
Gifts which are made on a regular, but not necessarily pattern-based basis, of consistent value and to the same person.
Rather than taking money out of savings or investments to make a gift to a loved one, gifts from income are regular, or usual amounts which are given to another person, without expectation of repayment or anything in return.
To qualify for IHT relief, the gifts must satisfy three criteria, in order. They must:
- Be part of the gifter’s normal expenditure
- Be taken from the gifter’s normal annual income
- Not affect the gifter’s ability to maintain a normal standard of living
‘Normal expenditure’ is a confusing phrase used in official documentation which refers to the spending habits of the individual person making gifts. For example, if a person regularly spends their own money on clothing for grandchildren, it may be considered part of their normal expenditure if they instead choose to gift a set amount to the parents each month, to provide for them.
When determining whether the gift affected the transferors’ ability to afford their own standard of living, the government will consider their typical spending habits and living costs, to compare any changes.
To qualify for IHT relief, the gifts do not need to be strictly regular. For example, it is not necessary to prove that gifts were made on the same day each month. But, there should be an easily discernible pattern to the gifts.
What doesn’t qualify?
There are several gifts which will not qualify for IHT relief, including:
- Gifts given for a special occasion, such as a wedding or graduation
- Gifts a made from income accumulated over many years
- A gift given in the year prior to death, which cannot be proven to be the start of a regular arrangement
Of course, most arrangements are not written down, or set in any legal way. That doesn’t mean that the gifts will automatically be rejected and have IHT liability placed on them, but the more evidence that is available, the better.
For this reason, it is best to plan ahead if you intend to begin making regular gifts from income to reduce your IHT liabilities.
Why choose this method?
Gifts from income have benefits for everyone involved. You can reduce the amount lost in IHT upon death, and your loved ones receive a helping hand financially. Emotionally, it can be nice to see loved ones live a better quality of life due to the help you are providing, and the smile of relief from stressful expenses alone is priceless.
For more information on gifts from income, or to discuss your estate planning options, contact us on 0345 222 0275.
