How to reduce Inheritance Tax: Regular financial support for your children
Posted on 13th November 2023
These payments are known as ‘gifts out of surplus income’. To qualify they mustn’t reduce your quality of life or be made from your capital.
With property prices increasing and tax thresholds frozen more families are likely to pay 40% IHT. The Office for Budget Responsibility says the Treasury is likely to receive $8.7billion from IHT in the 2027/28 tax year. This compares with £6.1billion in 2021/22. However, according to The Telegraph, only 430 families used this rule last year to reduce the IHT they paid.
How IHT affects beneficiaries
IHT applies if your estate is worth more than £325,000 (the nil-rate band) when you die. Your beneficiaries will pay 40% tax on the value of your assets above this threshold. There is an additional £175,000 allowance when direct descendants inherit your main home (residence nil-rate band), making the threshold £500,000. Married couples can combine their allowances, making a total of £1million.
Gifts made during your lifetime can help keep the value of your estate below these thresholds. As a UK taxpayer you have annual gift allowances that can be made from your capital. If you give more, the seven-year rule means IHT will still apply on a sliding scale for seven years. However, this doesn’t apply to gifts made out of your income.
Checklist for gifts out of excess income
To avoid the seven year rule for inheritance tax your gifts must be:
part of your ‘normal expenditure’ which you give regularly
paid out of income such as your salary or pension
affordable once you’ve paid your normal outgoings so you don’t reduce your standard of living.
What is ‘normal expenditure’?
Gifts from your income are normally given over a period of at least three or four years. This shows HM Revenues and Customs (HMRC) they are made regularly. A single gift only qualifies if it is clearly intended as the first of planned regular payments. Regular gifts should each have around the same value. However, if your income is variable because you receive dividends, for example, you can probably make gifts of different sizes.
What HMRC sees as income
Your income can come from employment, property rentals, pensions, interest and dividends. Capital assets such as securities or jewellery don’t qualify. You can only give capital assets if bought with income for someone specific as part of your normal payment pattern.
HMRC checks your income during the year to see if the gifts were affordable. However, income saved for two or more years before giving gifts could be seen as capital, which wouldn’t qualify.
Keep good records for IHT
When your executors complete the IHT forms after your death they must have evidence your gifts came from income. You can help them by keeping good records of your gifts, income and outgoings for each year. Useful information includes your:
care home fees.
Please get in touch if you would like to know more about giving gifts out of your income.
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