Tis the season for gifting

As the nights grow ever darker in the inexorable lead up to the winter solstice, lights, trees, and decorations begin to adorn our homes, and our thoughts naturally turn to the giving of gifts. Whilst we can’t help with choosing the perfect stocking filler for a discerning family member or track down an elusive PlayStation 5 for the gamer in your life, this season of giving is an ideal opportunity to clarify some financial misconceptions and the implications of making larger gifts.

Giving money away, or ‘gifting’, in your lifetime has always been the simplest form of planning to reduce inheritance tax (IHT). With the nil rate band for IHT remaining stubbornly fixed at £325,000 since April 2009, any assets you own above this level, after accounting for any debts (and, in general, excluding pension funds), could be subject to 40% tax upon your death.

A key exemption allows legal spouses (including civil partners) to give away assets to each other without incurring any IHT. As a result, if your Will instructs that all your assets should pass to your spouse or civil partner, there would be no IHT to pay on your death. Passing on assets to your spouse in this way does not use any of your £325,000 nil rate band, however this valuable allowance would not be lost. Instead, any unused allowance can still be claimed by your surviving partner’s estate when they die, effectively giving them a total IHT-free amount of £650,000.

Giving away money during your lifetime (rather than waiting to pass this on by way of an inheritance after your death) can therefore help to reduce a potential IHT liability. Contrary to common belief there is no tax to pay at the point of giving a cash gift, for either the donor or recipient. From the IHT perspective of the donor, however, any gift of value (be it in the form of cash or any other asset) is classified as a PET – a Potentially Exempt Transfer.

This is where the more well-known “seven-year rule” comes into effect. If you were unfortunate enough to die within seven years of making a gift, then the PET fails to become exempt and instead becomes chargeable, resulting in the value falling back into your estate for IHT and being taxed accordingly. In this situation there is some relief available from the 40% tax rate, on a sliding scale, if death occurs more than three years after making the gift.

It is therefore vital to consider your own age, state of health and even your family history when thinking about making any significant gifts, and naturally doing so whilst you are (relatively) young and healthy remains the preferred option.

Although there is no tax to pay, or reporting required, at the time you make a gift, it is recommended that you keep your own records of the date, amount and recipient of any lifetime gifts you make, just in case your executors ever need this information.

As well as the exemption between spouses, there are several other circumstances where gifts are exempt from IHT, and the attaching seven-year rule, including:

1. The first £3,000 of gifts you make each year (the annual exemption)
2. Small gifts to any number of individuals, of up to £250 per person
3. Wedding gifts (which must be made before the wedding)
4. Up to £5,000 given to a child
5. Up to £2,500 given to grandchild or great-grandchild
6. Up to £1,000 given to any other relative, or friend

Touching on the spirit of festive giving to benefit those less fortunate, any money that you give to charity is also exempt. Somewhat counter to this notion, a similar exemption also applies for donations to political parties.

More significantly, there is also a broader exemption from IHT which applies to regular gifts which are made from surplus income. There are no specific limits to this exemption, however, to qualify, gifts must:

1. form part of your normal expenditure and a habitual pattern of giving,
2. be made from income, and
3. leave you with enough income to maintain your usual standard of living.

As these three tests are subjective in nature, it is vital that you maintain detailed records of any regular gifts to aid your executors in proving that your gifts have met the conditions for exemption under the gifts from income rule.

What could be deemed as “surplus income” will naturally vary from year to year depending on your changing circumstances, however the value of regular gifts does not need to be a fixed amount, or even to the same person, to qualify as a habitual pattern. It is, again, vital to make a written record in the form of a letter as evidence of your intention to make regular gifts.

With the rules surrounding gifting being governed by a complex and nuanced set of rules, we suggest that you seek professional advice to help make best use of the exemptions available.

By considering your broader financial situation, working with a financial planner can help you first to establish the extent of your IHT liability, and then explore your capacity to make lifetime gifts, to ensure that your generosity today does not prevent you from meeting your own long-term needs. In tandem with this a detailed cashflow plan, regularly updated, can be used as evidence to justify ongoing gifts from regular income.

With allowances staying static, tax receipts from IHT have been increasing steadily year on year. By embracing gifting as part of a wider planning strategy you can witness the enjoyment of your generosity first hand, which should provide far more cheer than any potential reduction in your future tax bill, and hopefully last far longer than the Boxing Day leftovers.