Mercer & Hole’s Liz Cuthbertson answers typical client questions when it comes to making a gift to your family and friends (to reduce the value of your estate for Inheritance Tax [IHT]). Estate planning is a complex subject matter and getting professional advice is key to avoid the big pitfalls when making a gift.
Making gifts is simple, tax efficient and easy to administer on a practical level. Gifts can be exempt or potentially exempt from IHT depending on what they are and to whom they are made.
An exempt gift reduces the donor’s estate (the person making the gift) immediately without any further conditions attached, but a potentially exempt gift reduces the donor’s estate once the donor has survived a full seven years from the date the gift is made.
Is there any limit to the amount of regular contributions you can give a loved one? Or is it just a case of proving they come from earnings, not savings?
It is possible to make a gift out of an individual’s surplus net income of the tax year. Provided they qualify, the gifts are exempt from IHT. UK tax legislation sets out specific conditions that must be met for a gift to qualify:
- The gift formed part of your normal expenditure
- The gift was made from income
- After the gift, you were left with sufficient income to maintain your normal standard of living
Other factors that may be considered include the frequency and amounts of the gifts, the nature of gifts, the identity of the recipient, and reason for the gift. After the gift, the donor must be left with sufficient income to maintain their normal standard of living. This is a subjective test but preparing an analysis of income and expenditure each year is the best way to demonstrate this.
As you can see, it is important to be able to demonstrate that the gift comes out of income and not accumulated capital. Although there must be some regular pattern about the giving, the amount does not need to be fixed. The amount gifted can be increased or decreased depending on the donor’s own needs in a given year. This could be particularly helpful in times where everyone is facing uncertainty of income. You could set up a regular pattern of giving and simply adjust the amounts to suit your own affordability over time.
Other than annual exemptions and regular contribution rules, are there any other IHT tax rule limits that people should be aware of when paying into ISA’s?
The main aspect to be aware of is that any gift that is not covered by an exemption is likely to be a potentially exempt transfer (PET) – this means the donor must survive a full seven years from the date the gift is made before the gift falls out of the donor’s estate fully for IHT purposes.
There are further exemptions in addition to the annual exemption and gifts out of income. One of them is the small gifts exemption, under which an individual can make a gift of up to £250 to any person in the tax year and this is fully exempt provided you have not used another exemption on the same person in the year. This could be useful to make a small gift to a person’s ISA. There is no limit on the number of people you can make the small gift to.
It is important to remember that if the £250 limit is breached, the whole amount becomes subject to IHT. The relief can be used in conjunction with other planning strategies but is useful to benefit a wide range of individuals on a yearly basis.
With the annual exemptions for weddings and civil ceremonies – can that money be used to pay for the wedding or give as a wedding gift too?
Wedding or civil ceremony gifts can also be exempt but there are limits to what can be gifted free of IHT:
- up to £1,000 for any individual
- £2,500 for a grandchild or great-grandchild
- £5,000 for a child
In terms of the timing of the gift – it should be done on the day or shortly before the ceremony – once gifted, the funds could be used to pay for a portion of the wedding if necessary. In order for the above gifts to qualify, the wedding must happen and therefore, in the current circumstances, if anyone has made a gift under this heading and the wedding has not been able to take place, the gift would not be exempt but potentially exempt and subject to the seven year survival rule.
You can combine this with the annual exemption to allow you to give an increased amount to an individual in the tax year of their marriage. It would also not have an impact on any gifts out of income made to the same individual.
Also, what happens if someone dies before their family member has paid off the loan and the records about loan repayments aren’t up to date?
If a person dies with loan repayments outstanding, the debt can usually be settled out of the estate of the deceased. If the records are not clear about what has been repaid, the position can usually be ascertained and constructed from bank statements.
To discuss any of the questions raised in this article please contact Liz Cuthbertson or a member of the Private Client team.
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