When considering tax planning options, lifetime gifts which are exempt from IHT are often overlooked. They are a useful, tax efficient way of reducing the size of your estate and passing wealth down the generations, subject, of course, to ensuring that you have sufficient funds for your own needs.
One of such exemptions is 'normal expenditure out of income', that is, giving away your surplus (after tax) income but ensuring that you are left with enough income to maintain your usual standard of living without dipping into capital. A regular pattern of giving is required, such as paying the premiums on a life policy for another's benefit or meeting annual school fees for a grandchild. The first in a series of gifts can qualify, provided further gifts are intended and provided there is sufficient evidence of that intention, should you die before the second gift in the intended series. Clients should be aware that the money must be income, so, for example, income which is then invested loses its character of income and so would not be exempt from IHT if given away. This exemption must be claimed by the Personal Representatives (PRs) after death and it is helpful if the deceased kept a careful record during his lifetime so that the PRs can present HMRC with the relevant figures as evidence. With the new rules introduced for 'excepted estates', that is, estates which do not need to submit a full IHT account to HMRC, PRs should be aware that gifts over £3,000 which would normally be exempt from IHT as gifts out of income, are now included as part of the deceased’s chargeable estate and so could cause the gross value of the estate to exceed the IHT threshold (currently £325,000) and so require the PRs to complete the full IHT account.
Other useful lifetime gifts exempt from IHT are the annual exemption of up to £3,000, gifts on the occasion of marriage, the exempt maximum of which varies according to the closeness of the relationship with the bride or groom, and small gifts up to a total of £250 to any one individual during a tax year. Potentially exempt transfers (PETs) are the more well known IHT exempt gifts which must be absolute gifts (so gifts into trust are not PETs) and can be of any amount. PETs become fully exempt from IHT if the donor survives for at least seven years after making the gift. If the donor fails to survive for seven years, then the gift becomes chargeable and will use up all or part of the donor's nil rate band. However, the longer the donor survives after making the gift (subject to surviving at least three years), the lower the IHT charge.
Clients should be aware that the Government and HMRC keep such IHT exemptions under review, not least with the setting up of the Office of Tax Simplification which recently carried out reviews into all tax reliefs, allowances and exemptions for individuals across all taxes administered by HMRC. Therefore, while these gifts are exempt from IHT for now, there is no guarantee that they will be available in the future, so you should bear this in mind when considering your tax planning options.