Lifetime gifts and Inheritance Tax (IHT) – the facts
By making lifetime gifts and taking advantage of certain exemptions and reliefs, you can gradually reduce the value of your estate that would normally be subject to Inheritance Tax over time, potentially minimising the tax liabilities for your beneficiaries.
Lifetime gifts can be an effective means of ensuring that the Inheritance Tax residence nil rate band (up to £175,000 per spouse or civil partner) is claimable on the second death.
What is a lifetime gift?
Simply put, a lifetime gift is the transfer of property, assets, or money from one individual (the donor) to another person or entity (the recipient) during the donor’s lifetime.
A lifetime gift can take various forms, such as giving a valuable possession, transferring property or real estate, providing a sum of money, or making an investment in someone’s name.
The difference with a lifetime gift is that it is made during the donor’s lifetime rather than being distributed as part of their estate when they die.
PETs and CLTs
Lifetime gifts essentially take two forms – a potentially exempt transfer (PET) where it becomes exempt from IHT if the donor survives for at least seven years or a chargeable lifetime transfer (CLT), for example, a gift into trust, which is subject to immediate IHT or may become subject to IHT if certain conditions are not met. The government’s website provides a useful guide to working out Inheritance tax due on gifts.
Take the example of a married couple with total assets of £2.7m including the marital home valued at £700,000. Let us assume that none of their assets qualifies for any special reliefs from Inheritance Tax such as BPR or APR.
(BPR stands for Business Property Relief – this reduces the value of a business or its assets and APR is Agricultural Property Relief – subject to conditions, both can provide either 50% or 100% reliefs).
Let us also assume that they have mirror wills leaving their assets to their spouse and then to their children. As matters stand, on the second death, no residence nil rate band would be claimable owing to the effect of the tapering restriction. Only two standard nil rate bands (2 x £325,000 = £650,000) would be available.
However, if the couple were to gift assets valued at £700,000 during their lifetime, then (assuming no changes in asset values) the maximum £350,000 of residence nil rate band would become claimable on the second death, saving Inheritance Tax of £140,000 (£350,000 @40%). The residence nil rate band would no longer be tapered away, as the death estate of the second spouse to die would not exceed £2m.
If both spouses were to survive seven years from making the £700,000 lifetime gift, then the £700,000 would become an exempt transfer, and Inheritance Tax of £280,000 (£700,000 @ 40%) would be saved.
So, in my example, total Inheritance Tax of £420,000 (i.e. £140,000 + £280,000) could be saved by gifting £700,000 in lifetime – an effective tax saving rate of 60%.
Smaller lifetime gifts and other exemptions
It is important to remember that each person has an annual exemption of £3,000 and in addition, smaller gifts of up to £250 per person, per tax year are also exempt from IHT.
Regardless of the seven-year survival rule, there is no Inheritance Tax to pay on gifts between spouses or civil partners and there is no Inheritance Tax to pay on gifts you give to charities or political parties.
You can also make regular gifts from your income without them being subject to IHT – known as the ‘normal expenditure out of income’ exemption, they must be made as a pattern of regular giving and not reduce your standard of living.
Important to remember
For a gift to be considered a lifetime gift, it must involve the irrevocable transfer of ownership and control of the gifted assets to the recipient. Once a gift is made, the donor will typically relinquish all rights and control over the gift. Care must be taken to ensure that the donor does not retain any enjoyment or benefit from the asset gifted since the “gift with reservation of benefit” anti-avoidance provisions could otherwise apply to treat the asset as remaining within the donor’s estate for inheritance tax purposes.
More help and advice
The CGT and other tax ramifications of making lifetime gifts of assets must always be considered in tandem with the Inheritance Tax position. The legal and financial planning aspects must also be addressed. And the relevant property trust regime effectively places a cap on the value of assets that a married couple can gift into trust (£650,000) before the lifetime Inheritance Tax rate of 20% kicks in.
While making lifetime gifts can be very effective to reduce the value of your estate, to potentially minimise the IHT liabilities payable by your loved ones after you die, it is crucial that you get professional advice to consider all tax implications. Simon Valentine Marsh’s blog also looks at reviewing your estate in relation to Inheritance Tax.