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Inheritance tax planning: how to utilise exemptions and reliefs

inheritance tax planning - exemptions and reliefs

Inheritance tax is becoming a concern to more and more people. A simple yet effective way of planning is to use exemptions and reliefs and use of the normal expenditure out of income exemption can be particularly useful.

It is a fact that inheritance tax receipts are increasing and the number of families paying inheritance tax is now at a 35 year high.  In 2009/10 2.6% of deaths gave rise to IHT.  In 2015/16 this was 7.1%.   And the expectation is that the tax receipts will increase still further with a prediction of £5.6 billion from tax year 2020/21.

Inheritance tax is obviously affecting more estates and will continue to do so.

Many people will be keen to take practical action that can reduce the impact of the tax without materially affecting their standard of living or financial security.

One of the accepted forms of IHT planning is to make lifetime gifts.  Provided these are potentially exempt transfers (PETs) and the donor lives seven years these will be totally free of inheritance tax.

The drawback with PETs is that, in general, they need to be outright gifts and so ongoing control is lost.  This can be overcome by making the gift to a trust (usually a discretionary trust) where the donor can be a trustee and decide who should benefit in the future.  The drawback with discretionary trusts is the need to not exceed the donor’s nil rate band taking account of what has been gifted in the preceding 7 years.

Many people may not however have assets that they can easily gift to the next generation but do have substantial levels of income – some of which may be surplus to their requirements.

Income in this respect means earned income and investment income (including buy-to-let income).

Such people can therefore make regular gifts of income and provided such gifts are the following they will be exempt when made.

  • regular; and
  • made out of income; and
  • do not affect the donor’s usual standard of living

This means that there is no requirement that the donor need to survive them by 7 years as with other gifts.

And that applies if the gifts are outright (PETs) or to a discretionary trust (chargeable lifetime transfers).

How can an individual utilise such a gifting strategy if he/she has surplus income?

There are a number of opportunities and here are a few to ponder over:

  • a grandparent (or parent) makes regular payments into a Child Trust Fund/JISA for the benefit of a grandchild;
  • parents paying premiums into a joint lives last survivor whole of life policy in trust for children to provide a lump sum fund to meet IHT on the second death; or
  • parents making a regular (annual) contribution to a single premium bond held in trust for their family.

The key issue is that the payments must be made regularly.

Finally, another important point.  On an individual’s death, HMRC may want evidence that the payments did not affect the deceased’s standard of living and this may prove difficult for the executor to demonstrate – given that they will now be unable to discuss it with the deceased!

To avoid this problem, the donor should keep records of his/her regular gifts and his/her associated financial circumstances as and when he/she makes gifts.  This can be recorded on Form IHT 403 – the normal expenditure form that needs to be completed as part of the estate return on a person’s death.

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