Did you know that regular lifetime gifts out of excess income are immediately exempt for Inheritance Tax (IHT) purposes. It is irrelevant whether or not the donor survives for seven years or what the available nil rate band is.
Gifts out of income can also be used in conjunction with other gift exemptions and with trusts but for the exemption to apply it must show that a transfer of value meets three conditions.
It formed part of the transferor’s normal expenditure and was regular.
There must be evidence that the intention was to make regular gifts over a period of time, ideally three to four years. This evidence could take the form of a letter stating the intention to make the gifts or a pattern such as the payment of annual premiums on a life policy for the benefit of someone else. The gift amount can vary.
The gifts were made out of net income after tax
For example out of salary, commissions, rents, dividends from shares and interest paid on bank accounts. If there was evidence of one bad income year among several normal years that disrupts the gift patten, this will not result in the loss of the exemption assuming the gifts then start again.
HMRC will likely consider accumulated income as becoming capital after two years, so gifts made out of older accumulated income should be carefully considered and beware of gifts characterised as a return of capital rather than income, such as gifts from income subsidised from a discounted gift trust.
The transferor had enough income to maintain his/her normal standard of living
Evidence of the transferor being left with enough income to maintain his/her normal standard of living with resorting to capital to meet living expenses is needed. Examples of normal expenditure are regular premium payments on an insurance policy for another person.
HMRC’s advice is to keep a record such as a simple account of net income and expenditure for the tax year, together with details of the gifts made. If circumstances change, but the pattern of gifting has been established, a person can stop making the gifts without losing the exempt status of this qualifying gifts already made.
Even without deliberate planning, anyone making regular gifts for several years before their death may inadvertently achieve the exemption conditions so it is worth checking. It is claimed by the executors after the death of the donor.
Gifts made out of income is an exemption that is underused but very useful. Here are some ideas of how it can be used…
| Use excess income to allow others to make use of their ISA and JISA allowance. |
| Income transferred into trust normally attracts a change to IHT if the nil rate band is exceeded, but not where regular gifts out of income are made (although there is an IHT charge every 10 years based on the value of the trust’s assets if they exceed the nil rate band and no furth er planning is undertaken). |
| A client could settle a £300,000 insurance band into a discretionary trust and make ongoing exempt gifts into it with which the trustees pay into the band. No matter when the settlor dies, there is no IHT due. |
| A client could regularly pay the premiums of a large ‘whole of life’ policy written in trust and paying out of death. The policy premiums, which are purchasing a benefit for others, will not be subject to IHT as they would be from the settlor’s excess income. |
| Making pension contributions for family members takes the gifts out of the donor’s estate for IHT purposes and benefits from basic rate relief at source from HMRC, effectively increasing the gift by 25% and other tax reliefs may be available. Bear in mind you cannot normally access your pension until age 57, which will increase in line with state pension age. |
Note: ISA dividends/interest can be included as income, as can attendance allowance payments, even though they are not taxable.
The Financial Conduct Authority does not regulate Trust and Estate Planning. IHT thresholds depend on your individual circumstances and may change in the future.
If you want to know more about how you can give gifts from your income, we can help. Please get in touch by emailing info@resolvefs.co.uk or call 01932 943028.