Estate planning and preparing for the future can be a daunting task. Even more so with the worry of your estate befalling a large inheritance tax (IHT) bill, leaving your loved ones with less than you wished to give them. Below we explain some transfers that can be made during your lifetime that will either spread the cost of your IHT liability or exempt the transfers of certain assets.
Exempt Transfers For IHT Liability
There are several instances where transfers can be made and not incur an IHT liability either because of the person to whom you are making the gift or because of the value of the gift.
Gifts Within Your Annual Exemption:
Each individual can make gifts of up to £3,000 per annum plus any unused annual exemption from the prior tax year (the current year is fully utilised in priority).
Gifts between spouses or civil partner who are both UK domiciled are exempt without limit. For many years a non-domiciled spouse transferee could receive up to only £55,000 as an exempt transfer. Since 2013 the limit has been £325,000. A non-domiciled spouse could receive up to £650,000 tax free from their late spouse/civil partner: £325,000 inter-spouse exemption and £325,000 nil rate band.
If you have a friend or family member who are entering into a marriage or a civil partnership, your gift will benefit from the gift of marriage exemption. There are various thresholds on the value of the gift dependant on how close the relation, for example, as a parent of the bride or groom the exemption is £5,000; as the grandparent it is £2,500; for any other relation it is £1,000.
Small Gifts Exemption:
Annually, you can make gifts that amount to no more than £250 per person. This cannot be accrued between individuals i.e. you cannot give a parent £500 in order to gift their two children £250 each, you will need to gift the amount to the children directly. It should be noted that if the gift exceeds £250 (even by just £1) the whole amount could be subject to IHT (subject to other reliefs and exemptions).
Gifts Out Of Disposable Income:
If you are generous by nature and usually give gifts to your family and friends, then it could also be considered exemption if it is ‘classified as normal expenditure out of your income’. However, this is on the basis that the gifts do not decrease your estate in any way, and this should be evidenced.
There are several other forms of gifts including gifts to charity, gifts to political parties, gifts to housing associations and gifts to certain national institutions, which can all be exempt if the recipient meets certain conditions.
Potentially Exempt Transfers (PETs)
Potentially exempt transfers (PETs) are gifts made by an individual to another individual during their lifetime. PETs are not taxed at the point they are made. However, they may or may not (hence the potentially) become taxable in the future. The donor must survive the gift by seven years for it to become exempt, if they do die within seven years of the transfer then the gift will be included as part of the donor’s estate for IHT purposes. As a result, the PET would be considered as having failed.
If the donor survives the gift more than three years, then the gift will be subject to taper relief and the charge to IHT will be reduced. The PET is considered a PET until either the death of the donor or the seventh anniversary of the gift, and depending on which event occurs first, the gift will either be considered exempt or will become chargeable.
If the PET was made more than seven years ago, then it will not be included in calculating the individual’s estate. However, if the individual dies before the seventh anniversary, the PET will have failed and is included in the estate for IHT purposes.
Chargeable Lifetime Transfers
A chargeable lifetime transfer may occur when an individual transfers property into a trust during their lifetime. The lifetime rate of IHT is 20% or 25% (depending on whether it is the donor or the trustees who pay the liability) of any amount that exceed the nil rate band. If the gift is below the threshold then the individual will have no IHT to pay, but may be charged to capital gains tax.
IHT is calculated on a seven-year cumulative basis. So, when you are considering making a lifetime transfer it would be prudent to plan each transfer. Every seven years your threshold resets and you then can make more transfers without incurring a charge to IHT. Bear in mind that if you are also considering making a PET, it is best to make the lifetime transfer first in order to use your threshold. As stated above, a PET will be considered exempt until either your death or the seventh-year anniversary.
If the individual who has made the transfer dies before the seventh-year anniversary, then (very much in the same way as PETs) the lifetime transfer will have to be included in the individual’s estate. In this instance IHT will be charged at 40%, but relief will be given for the tax already paid. Lifetime charges are also subject to taper relief which means that depending on the length of time the donor survives the lower the IHT will be! Taper relief applies where a transfer is more than three years ago and increases as surviving gets closer to seven years.
IHT Liability Planning
The exemptions and other available reliefs can be used to put family wealth in protective structures such as trusts, which would otherwise give rise to an IHT charge. Due to the limitation of the exemptions and availability of reliefs, IHT liability planning needs to start relatively early – normally when the cost of life insurance outweighs not planning!
There are lots of IHT liability planning options and not one solution will be right for each person.