Anyone with assets above the inheritance tax allowance of £325,000 is likely to be concerned about the amount that may have to be paid in tax after their death. If circumstances permit, they may want to consider trying to reduce the value of their estate by making lifetime gifts to friends and relatives.
In general, people wishing to make lifetime gifts would have to survive seven years before these would cease to be treated as part of their estate for inheritance tax purposes. There are some exemptions to this rule which include an annual allowance of £3,000 and small gifts of up to £250 to others who have not received a share of the £3,000. These exemptions have not increased since they were introduced in 1984 despite the publication of an All Party Parliamentary Group report in January 2020 suggesting that the various exemptions be replaced by a single annual gifting allowance of £30,000.
However, even with the lifetime gifting exemptions at their current levels, there is still potential for people with surplus income to make considerable inheritance tax savings by making gifts out of income. There is no limit on the amount which can be given away without incurring inheritance tax provided that the gift fulfils all the following conditions:
- It forms part of the giver’s usual expenditure
- It is made out of income
- It leaves the giver with sufficient income to maintain their normal standard of living
Gifts of income could be in the form of money being given to the recipient or as payments made on their behalf such as towards their mortgage, school fees or pension pot. It is even possible for payments to be made to cover the premiums on a life insurance policy written in trust which the beneficiary wouldn’t receive until after the donor’s death so long as they are not linked to an annuity.
It is easiest to show that a gift of the same amount made on a regular basis is a gift of income rather than capital. They don’t always have to follow this pattern though, especially as income could fluctuate and so could the income needs of the giver. If it is not possible to establish a settled pattern of expenditure, then it is important to retain documentary evidence of a commitment to making gifts of surplus income as can be seen in the contrasting outcomes of the 1995 case of Bennett v IRC and the 1997 case of Nadin v IRC.
In Bennett v IRC, the court considered gifts made by an 87 year old widow who was entitled to the income from a trust. The trust did not produce much income originally but it was enough to meet her needs. The income increased substantially once capital was available for investment following the sale of the trust’s interest in the family business in 1987. She was in good health and believed that she was unlikely to require additional income. She therefore instructed the trustees to make gifts of the trust income which was surplus to her financial needs equally between her children in January 1989. The following month the trustees made payments to each of her children of just under £10,000. In February 1990, they made further payments of £60,000 to each of the children. The widow died unexpectedly less than two weeks after the second set of payments. The court held that these payments constituted part of the widow’s normal expenditure and so were exempt from inheritance tax.
In Nadin v IRC, the taxpayer paid care home fees of £13,000 from an annual income of just over £18,000 but had made several substantial cash gifts to relatives totalling £270,000 while she was in residential care. The court considered the accumulated income her executors claimed they had been paid out of had become capital. Although there had been some gifts in the years before she moved into the care home which did genuinely appear to have been made out of surplus income, as these were irregular and there was no evidence of a commitment to make payments, the court held that these were also taxable.
(Please note: This article was originally published on our previous website and is provided for general information purposes only. While it reflects the legal position at the time of writing, the law may have changed since publication. For up-to-date advice tailored to your circumstances, please contact our team.)
