Regular gifts out of income are a tax-efficient way to transfer wealth between the generations and build capital for your family’s future.
In many families, there are now more generations living at the same time than ever before.
As a result, you are more likely to provide financial support to family members during your lifetime than after you die. One tax-efficient method is to make exempt gifts; in this, the second of two articles on the subject, we examine more of the options available.
Gifts are a useful way of reducing the Inheritance Tax (IHT) bill which your estate may eventually have to pay on the value of assets in excess of the available nil-rate band. Every tax year you can make tax-exempt gifts worth a total of £3,000, and separate tax-exempt ‘small gifts’ of up to £250, to as many people as you like (see link to Generosity pays on the right hand side).
There are other ways of gifting which are not dependent on the tax year cycle and which, over time, can add up to substantial sums. The most useful are what HM Revenue and Customs (HMRC) calls ‘normal’ gifts out of income. Since it has the final say over whether any expenditure is IHT-exempt or not, it is important that these gifts meet HMRC criteria.
From income, not capital
The first requirement is that the gifts are made regularly. That could mean giving monthly or even annually, as long as each gift is clearly part of a regular pattern. The next requirement is that the gift is made out of income, not capital. More than that, once you have made the payment, you must still have sufficient income to maintain your usual standard of living. For that reason, what constitutes ‘normal expenditure out of income’ is down to individual circumstances. If you have to make sacrifices, the gifts are ineligible.
There are a number of different ways in which normal gifts out of income can be made to good effect. As we live longer, wealth is increasingly being transferred between generations during our lifetimes, and gifting can play an important part in that process. You could choose to help a child or grandchild save for university fees, for example, by setting up a regular savings investment such as a Junior ISA. Or you could use regular gifts to help a child raise enough for a deposit on their first home.
Double tax break
Many of us wish we had put more into a pension scheme when we were younger, or started saving earlier for retirement. You could use gifts out of income to help your children or grandchildren secure their own retirement in the fullness of time. Contribute to a family member’s pension and the gift will benefit from another associated tax break.
If you pay £2,880 into a child’s pension, for example, basic rate tax relief will boost the contribution to £3,600. Over five years, with gifts of £14,400, the child would benefit by £18,000. If you left the £14,440 in your estate, IHT could promptly slash it to £8,640, so the advantages of gifting are obvious.
Keep a record
Monetary wedding presents, or ‘gifts in consideration of marriage’, are another type of exempt gift, though the allowable amount will vary depending on your relationship to the couple. If you are the parent of the bride or groom, you can give them up to £5,000. A grandparent or great-grandparent may give £2,500. If you are not related to them at all, you can still give them an exempt £1,000.
All these amounts will move immediately out of your estate for IHT purposes. But, for these as for all other exempt gifts, you must make sure to keep a record so that your executors can prove that you used the allowances – and used them correctly. One way to do this is by completing an IHT403 form every year.
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The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.