Client Guide: Inheritance Tax - the use of lifetime exemptions
In considering tax planning, clients often overlook the lifetime exemptions available for Inheritance Tax (IHT). They may seem small, but used wisely each year significant tax savings can result.
Gifts made by any one person up to £3,000 are exempt in each income tax year – that is 6 April in one year to 5 April in the next year. The gifts are exempt from the outset. There is no need to survive the gift by seven years. The £3,000 can all be given to one person or it can be split between several people.
If the exemption is not used in one tax year, it can be carried forward to the next year, but only for one year. In using the ‘carry forward’ the current year’s exemption must be used first. For example, if in year one the annual exemption is not used and in year two £4,000 is given away, £3,000 of this uses the annual allowance available in year two and £1,000 of the annual allowance carried forward from year one. In year three, however, the unused £2,000 cannot be carried forward. Therefore careful note should be made of gifts to ensure the maximum benefit is obtained.
The £3,000 exemption, generally speaking, takes effect against the first £3,000 of total gifts so that, if you give away £10,000, the first £3,000 will be exempt, but £7,000 will be taxable if you die within seven years. This is in contrast to the small gifts exemption dealt with below.
Both husband and wife have a £3,000 exemption. If used systematically significant sums can be passed down over relatively few years, with no need to survive seven years. For example over four years, with one ‘bring forward year’ a couple can use ten annual exemptions – total £30,000 with a maximum tax saving of £12,000 on current rates of 40%.
Clients should note carefully the gifts they make to ensure the exemption is fully used. A gift by cheque is not effective till the cheque is cleared, so do not leave it too late before the end of the tax year.
Small gifts exemption
In any tax year an individual can give away a maximum of £250 to as many individuals as is desired. This is designed to cover birthday presents, Christmas presents and so on.
The £250 per person is the maximum exempt amount. If gifts with a value of £251 or more are given, the relief is lost and does not apply to the first £250, in contrast to the use of the annual exemption already referred to.
Please note that it is not possible to make an exempt gift of £3,250 to any one individual. The annual exemption and the small gifts exemption do not interact in this way. Only the first £3,000 would be exempt.
Gifts on marriage can in certain circumstances be exempt up to the following limits. Please note the exemption is per marriage.
- Parent to a party to the marriage £5,000
- Grandparent or remoter ancestor to a party to the marriage is £2,500.
- Any other person £1,000
The exemption also applies to the parties to a civil partnership ceremony.
Normal gifts out of income
This is a useful exemption but needs great care in its application and we would need to advise you in more detail. Very briefly gifts can be exempt if made regularly out of your income. After making the payment you must be left with sufficient income to maintain your usual standard of living. This is therefore only for the relatively wealthy who have sufficient income to give some of it away and still maintain their usual lifestyle. In addition there has to be evidence that each gift is part of a pattern. HM Revenue and Customs look at these gifts very carefully if a claim is made at death and you may need further advice from us regarding this.
Gifts to charities and political parties
Gifts to registered charities / sports clubs and the main political parties are exempt.
Life assurance/investment products
There is a wealth of products on the market aimed at investment and life assurance which have a tax planning angle. We can advise you about these in more detail.
Non-exempt lifetime gifts
Very briefly these fall into two categories:
- Potentially exempt transfers or PETs. These are gifts to individuals. No tax is payable if the person making the gift survives seven years from the date of the gift. The rate of tax reduces in the case of very large gifts only, if death occurs after three years but within seven years. One important advantage of making a gift is that it freezes the value of the gift. If you die within seven years, the value of the asset concerned at the date of the gift will be added back to your estate for tax purposes. Whereas, if you had retained the item, its value at your death would have been taxed.
- Lifetime chargeable transfers. These are gifts into trust. Such gifts are chargeable to tax at the outset, at special lifetime rates, if the gift exceeds the tax threshold (£325,000 for 2014/2015).