Families are on course to pay more than £8billion of inheritance tax (IHT) this financial year, another record high, and there’s worse to come as Labour lines up its autumn Budget tax raid.
The IHT nil-rate band threshold has been frozen at £325,000 since 2009, and will remain frozen until 2028. Families can potentially pass on a further £175,000 IHT-free via the main residence allowance, when passing the family home to children or grandchildren.
We don’t know what chancellor Rachel Reeves will do yet, but she could axe that additional allowance. She might also make unused pension liable to IHT on death, cut gifting allowances and limit IHT relief on businesses and agricultural land.
Planning is hard until we know exactly what Reeves will do, but it makes sense to use every possible method of reducing IHT exposure today. This includes one little-known option that allows families to make unlimited gifts to loved ones with instant IHT exemption.
Start by maxing out your annual gift allowances. Every adult can gift a maximum £3,000 a year IHT-free, so couples could gift £6,000 in total. They can mop up last year’s allowance too, if unused, to give £12,000 in total.
Every adult can also make unlimited IHT-free gifts of up to £250 per person, provided the recipient has not benefited from the £3,000 allowance.
Parents can also gift £5,000 to a child on marriage, or £2,500 to a grandchild or great-grandchild who is getting married, and £1,000 to a relative or friend.
Any further gifts are known as “potentially exempt transfers” and only fully escape IHT if you live for seven years after making them (the percentage tax charge falls on a sliding scale over that time).
These options are well known but another isn’t. It’s known as the “normal expenditure out of income exemption”, although it’s sometimes called “making gifts from surplus income”.
Rachael Griffin, tax and financial planning expert at wealth manager Quilter, said this could allow families to move much larger sums out of HMRC’s clutches. “It is particularly useful for those who still work, or who have some income they don’t need to cover their normal living costs.”
You can pass on as much as you wish, provided you can show that you have enough income left to fund your usual standard of living. Those on higher incomes can potentially give a lot more, Griffin said. “How much will depend on how much you earn and your standard of living.”
You could use the money to fund pension or Isa contributions for adults or children, cove school fees, pay a child or grandchild’s rent, or send the family on regular holidays every year.
However, you must meet certain criteria to avoid falling foul of HMRC.
Payments must be from your current income, which may include earnings, dividends, interest, rental income or pension income. Income saved from previous years is typically viewed as capital and deemed ineligible. So are one-off sources of cash, say, from a workplace bonus or property sale.
Griffin said gifts should also be consistent. “HMRC will look for a pattern of payments over a reasonable period, typically of at least three to four years. However, they don’t need to be the same amount on the same date.”
You must keep clear records of all gifts, plus income and regular expenses, to show HMRC if requested.
Obviously, not everybody can afford to do this. But as the Halloween budget looms on October 30, it’s worth checking out this forgotten option. Although there is a danger of Reeves could axe this, too.
