3rd June, 2016
To gift or not to gift…
And what is the order?
Gifting is a great way of passing wealth down to future generations, as well as potentially reducing inheritance tax. Our experience also points to greater satisfaction when gifts are made during your lifetime as you can see the joy that your gift brings to your chosen recipient, as well as potentially allowing them to benefit from it when they need it most.
You may have given your children or grandchildren regular financial gifts – pocket money, Christmas and birthday money, however what are your options when you want to give them larger amounts of money for things such university fees, a gap year or a deposit for a flat – and be as tax efficient as possible?
Many clients understand that they have some gift exemptions and reliefs from Inheritance Tax, however there is often a lack of clarity around specific rules, including the small gift allowance.
Giving money to your grandchildren regularly and in smaller amounts can be an effective way to minimise Inheritance Tax (IHT). You can gift £250 to as many people as you want every year. In addition, you have a £3,000 annual exemption allowance, though where the £3,000 is gifted, it can’t be increased by the £250.00 – told you it wasn’t straight forward!
Remember however, if you didn’t use that allowance in the previous year, you can carry it forward, giving you £6,000 which is exempt from Inheritance Tax.
Matters do get much more complicated if you make gifts that are above the small allowances. The timing of the gifts is very important. Again, most people have an idea that you need to survive 7 years following the gift if it is to be not taxed on your subsequent death, however most people are not aware that if you gift assets in the wrong way, this can extend this period a long time beyond 7 years!
Essentially there are two types of gift. Most direct gifts are called Potentially Exempt Transfers (PETs), whereas gifts into a trust are generally known as a Chargeable Lifetime Transfers (CLTs).
When someone dies, the gifts they made in the 7 years before their death are taken into account when calculating how much of their estate can be passed on free of inheritance tax, called the Nil Rate Band (NRB):
- If they were all CLTs, or all PETs, it is the total value of these
- If PETs were made before CLTs, it is their total combined value
Simple so far, but If someone dies having made a CLT in the 7 years before they made a PET, things become a little more complicated. This can be explained in the following example:
- Jim gifts £100,000 to a Trust in 2008, (CLT)
- In 2013, he gives his daughter £225,000 (PET)
- Unfortunately, Jim passes away in 2016
The NRB applicable at Jim’s death is £325,000. His executors need to check what gifts he made before he died and deduct this from the available NRB. The CLT was made over 7 years ago and so has fallen out of Jim’s estate, right? Technically, yes, but because this was made in the 7 years before the PET, the value is brought back in.
Jim’s executors have to add his CLT of £100,000 to the later gift of £225,000. This gives a total of £325,000 that the executors have to deduct from Jim’s NRB.
There is no tax to pay on the CLT as this is out of Jim’s estate, and none on the PET as it was within Jim’s remaining NRB. However, as there is now no NRB available to set against Jim’s remaining estate, it will be subject to inheritance tax at 40%.
Gifting as Jim has done can increase the amount of time a gift stays in the estate from 7 years to up to 14 years so it is important to consider the order that you make gifts. Part of our planning with clients is to ensure that your recipients remain the intended beneficiaries of your gifts and not the tax man.