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Gifting money to family from excess income can be a useful part of your inheritance tax planning

Benjamin Franklin famously stated that ‘nothing is certain but death and taxes’. While the former is still unavoidable, careful financial planning can substantially reduce the inheritance tax (IHT) payable on your estate when you die. A useful way to do this is by gifting money to family – from your capital or from income.

In this article, we look at gifting money to family by making inheritance tax gifts from surplus income or excess income.

Making inheritance gifts from surplus income 

If you want to make inheritance gifts from surplus or excess income, you need to show that you intend to make regular gifts which will not affect your normal standard of living, and which will come from income rather than capital.

There are a number of different ways your can do this, which we have outlined in this article. If you would like specific advice on your personal situation, please contact us for a free IHT planning consultation with one of our independent financial advisers.

Use excess income to buy a life assurance policy for IHT planning

If you have excess income, you could consider using it to buy a ‘whole of life’ policy which will be paid out on death and can provide a means to pay some of your estate’s inheritance tax bill.

In the example below, we explain how our independent financial advisers have set-up an inheritance tax plan using this approach to manage how much IHT our client’s family will have to pay.

A widow aged 65, Mrs Garnet has substantial assets - and a large part of her estate will probably be subject to IHT. She is not concerned with negating the entire IHT bill but wants to leave certain high-value items to her children.

Mrs Garnet wants to ensure a lump sum is available to her beneficiaries before probate is granted so that the high-value items won’t need to be sold to pay IHT. She has excess income each month, and she expects this to be the case for the rest of her life.

Mrs Garnet's Canaccord Genuity wealth adviser helps her to buy a £2m ‘whole of life’ policy which is medically underwritten and ensures that, as long as premiums continue to be paid, the policy will pay out the sum assured on her death. It's written into trust, so the proceeds won't form part of her estate and the funds will be paid to the trust beneficiaries (currently her children) before probate is granted. The policy premiums, which are purchasing a benefit for others, will not be subject to IHT as they would be from her excess income.

If you would like to discuss your personal situation with one of our IHT specialists, please click here for a free consultation.

Paying for school fees as an inheritance gift from surplus income 

In this example, our wealth adviser initially suggested that our client’s excess income could be used to pay for their grandchildren’s school fees in order to manage their future inheritance tax liability.

Mr and Mrs Jasper are both retired with generous final salary scheme pensions, plus investment portfolios and a savings account. They are now finding themselves with excess income each month.

Rather than let excess income build up in their estate and potentially create a future IHT liability, the Jaspers want to make regular gifts to help pay for their twin grandchildren's school fees. They write a formal letter to their daughter (the mother of the twins) informing her of their intention to make the gift on a continuing basis. They also keep a record of their ongoing income and expenditure, to demonstrate that the gift is being made out of surplus income.

After six years of making the regular gifts, Mr Jasper needs funds for private medical care and the regular gifting is no longer affordable. If circumstances change and gifting stops, the exempt status of gifts made previously does not change, as long as they have already qualified. 

Other types of regular inheritance gifting through excess income

Making regular gifts out of excess income can be a useful way to prevent further increases in your estate's taxable value. As well as funding whole of life policies or school fees, you could simply use regular gifts to fund:

  • Pension contributions for adults or minors
  • Building up ISA or JISA subscriptions, or
  • Sending the family on regular holidays every year.

What are the conditions for gifting from excess income?

If family or other beneficiaries wish to claim the gifting exemption, it will need to be claimed by the executors after the death of the donor and it must be shown that the gifting meets three conditions:

  • There is clear evidence of an intention to make regular gifts out of normal expenditure
  • The gift was made out of net income and not a transfer of capital assets; common sources are employment, rent from property, pension income, interest and dividends
  • The donor must be left with enough income to maintain their current standard of living, so they don't need to resort to capital to meet their needs. 

Keeping good records is the key to making a simple and successful claim for the exemption. Form IHT403 requires the details of annual income and expenditure in each year gifts were made. An annual record-keeping exercise, which your accountant can help with, will make the process much easier than trying to backdate records later.

Anything more substantial may be subject to tax if you don’t survive seven years after making the gift. However, many people are unfamiliar with gifting as part of their ‘normal expenditure’ i.e. giving away money from surplus income. This has the added benefit that you’re not giving away large capital sums that could provide you with ongoing income.

If you wish to read more about making the most of your gift allowances from capital, please read our other article here.

What next?

IHT rules are complicated and constantly changing. Your Canaccord Genuity wealth adviser can help you make sure your financial arrangements are up-to-date and take account of the latest legislation.

If you would like to know more about how we can help with your IHT and wealth planning needs, get in touch for a free consultation. We’ll be delighted to answer your questions and provide details of our services.

IHT planning advice

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Current IHT rates

IHT is charged at a rate of 40% on assets passed to beneficiaries (other than a spouse or civil partner) over and above the ‘nil rate band’ of £325,000. A new separate allowance, ‘the main residence allowance’ was introduced in 2017 which applies when someone leaves their main residence to their children or grandchildren. This allowance is currently £175,000 meaning an individual’s allowances could reach up to £500,000 before their heirs have to pay IHT. This new allowance is reduced for estates worth more than £2m and subject to certain conditions.

If you’d like to find out more about managing your IHT bill, read our other articles: 

The tax treatment of all investments depends upon individual circumstances and the levels and bases of taxation may change in the future. Investors should discuss their financial arrangements with their own tax adviser before investing.

The tax treatments set out in this communication are based on our current understanding of UK legislation. It is a broad summary and cannot cover every circumstance and it does not constitute advice.

Photo of David Goodfellow

David Goodfellow

Head of UK Financial Planning

David specialises in financial planning and tax driven investment planning. He has over 15 years' experience in advising on and investing in VCTs, EISs and tax driven property structures, and is part of the CGWM Advice and Solutions Committee. He is a member of the Personal Finance Society and The Chartered Insurance Institute.


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