A flexible way to mitigate inheritance tax exposure
Gifting money is often thought of in terms of large single outright gifts and the seven year inheritance tax (IHT) rule. However, regular gifts out of income can be exempt from IHT and provide a more flexible way to mitigate death duties.
The ‘Normal Expenditure out of Income’ exemption may be an interesting option for grandparents, parents and spouses looking to make regular cash gifts to their family while reducing the value of their estate for inheritance tax (IHT) purposes.
To use this exemption you make a series of gifts out of your after-tax income. If you satisfy the conditions, the gifts are exempt from IHT as soon as they are made and you do not have to survive for seven years. The exempt gifts also do not cut into your nil rate band.
If your circumstances change, you can stop the gifts without losing the exempt status of those you have already made. Particularly for this reason, this exemption is often more appropriate for many than a single large outright gift.
The Normal Expenditure out of Income exemption has the following three key criteria:
- Gifts must come from your annual net surplus income i.e. any monies leftover once you have deducted income tax and all expenses, such as household bills.
- Your gifts must be made regularly so that they become part of your normal expenditure. It is important to keep accurate records of all your outgoings so that you can show that these gifts form part of a regular pattern of giving. As it may take a few years to build up evidence of a pattern, it’s advisable to draft a letter, clearly setting out your intentions to make regular gifts each year to one or more named individuals.
- As the donor, you must be able to maintain their current standard of living i.e. the gifts mustn’t impact your ability to meet your day to day expenses.
It is important to know that HMRC may not assess the validity of the exemption until after your death. We advise all those considering this exemption to ensure that they have taken advice, documented their intention to make regular gifts out of income and that donors keep a running record of income and expenditure.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.