Giving can be a wonderful thing but in terms of estate planning, it can also be a very complicated subject.
If you’re thinking of reducing the value of your estate now to cut the cost of inheritance tax (IHT), as well as helping loved ones, there are a number of things to take into account.
Gifts are valued by the taxman by how much your estate is reduced, rather than the value the recipient receives. Gifts can be anything that has a value, including money, property and possessions.
To start with, there are certain amounts that can be gifted to individuals that will not incur IHT. You can give up to £3,000 without incurring IHT in any tax year, and if you don’t use this, it can be carried forward to the next, so that you can give up to £6,000.
You’re also allowed to make as many gifts as you like up to the value of £250 to anybody.
You can also avoid IHT if you gift to spouses or civil partners who live at the same address, charities and housing associations, national bodies like the National Trust, and political parties. You can also make gifts to people getting married or entering a civil partnership, depending on your relationship to them, from £1,000 to £5,000.
The Seven-Year Rule
There is a common misconception that transferring property to your loved ones during your lifetime will help save inheritance tax.
No tax is due on any gifts you give if you live for seven years after giving them – unless the gift is part of a trust. This is known as the seven-year rule. If you die within seven years of giving a gift and there is IHT to pay on it, the amount of tax due after your death depends on when you gave it.
Reservation of Benefit
If you are still alive seven years after gifting, there could still be potential tax consequences if you continue to benefit from the property. For example where a parent gifts the family home to a child but continues to live there rent-free whilst the child lives somewhere else is a reserved benefit. What this means is that the value of the property is still included in your estate for IHT purposes, even though you have given it away.
The Nil Rate Band
Anything of value above the gift allowances can be subject to IHT if you pass away before seven years from making the gift. If you live for three years, and the value of the gift exceeds the nil rate band, tax payable will benefit from Taper Relief, so the tax payable is reduced by 20% for each complete year you survive.
Once a gift becomes taxable, the value of the gift can be offset against an individual’s nil rate band. The nil rate band is the maximum amount that can be passed on without IHT being due and currently stands at £325,000. Whilst the gifts you have made may be covered by the nil rate band, it does mean there is less of the nil rate band available to be used against the value of your estate.
HMRC conducts random sampling of IHT returns and has been increasing this over the past few years. If a gift is discovered which hasn’t been properly declared, then additional inheritance tax will be due, and there may also be a penalty, as well as interest on the unpaid tax.
In order to avoid mistakes when it comes to gifting and estate planning, proper estate management is an absolute necessity. And you should always get the best, and most competent advice possible.