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Managing inheritance tax – gifting excess income

7 November 2018

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) on your estate when you die. A useful way to do this is by making gifts – from your capital or from income.

You may already be familiar with these tax-exempt gifts from capital:

  • Husband and wife or civil partners can give gifts of any value to each other during their lifetime, as long as they’re both domiciled in the UK
  • You can make gifts to other people, up to £3,000 in total in each tax year – although you can carry over one year’s unused allowance, allowing a maximum exemption of £6,000
  • You can make any number of gifts of up to £250 (one per person each tax year)
  • You can make gifts to people getting married, up to: £5,000 from each parent of the couple, £2,500 from each grandparent or more remote relative, £2,500 from bridegroom to bride (and vice versa) and between civil partners, or £1,000 from anyone else
  • Gifts to charity are exempt from IHT.

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.

Managing IHT through 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.

Gifting excess income – life assurance case study

Mrs Garnet, a widow aged 65, 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 beneficiaries.

Therefore, Mrs Garnet wants to ensure a lump sum is available to her children 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 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.

Gifting excess income – school fees case study

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.

Mr and Mrs Jasper write a 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 regular excess 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. 

Gifting through excess income – what to remember

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 use regular gifts to fund pension contributions for adults or minors, building up ISA or JISA subscriptions, or simply sending the family on regular holidays every year.

The exemption is 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, available here, 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.

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. We’ll be delighted to answer your questions and provide details of our services.

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 £100,000 meaning an individual’s allowances could reach up to £425,000 before their heirs have to pay IHT.

If you’d like to find out more about managing your IHT bill, read our five top tips blog here.

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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