When you make a gift to another individual this is known as a Potentially Exempt Transfer (PET). There is no Inheritance Tax payable at the time of the gift, but it has potential consequences for your Inheritance Tax position for seven years after the gift. After seven years, no Inheritance Tax will be payable on the gift at all.
There are a number of gifts to individuals that are totally exempt from Inheritance Tax:
• Annual Exemption – you can make an annual gift of up to £3,000. If it is not used in a tax year, the balance can be carried forward to the next year but is lost if not used that year.
• Small Gifts – gifts of up to £250 to any person (in any one tax year) are exempt. This cannot be used in conjunction with the annual exemption i.e. you cannot gift £3,250.
• Normal Expenditure – gifts are exempt if they are shown to be normal expenditure, paid out of income and don’t affect your usual standard of living.
• Gifts on Marriage/Civil Partnership – exempt gifts include: £5,000 from a parent of the couple, £2,500 from a remote ancestor e.g. grandparent of the couple, £2,500 from bride/groom to prospective spouse, £1,000 from any other person.
There are a number of other types of gift which are exempt, but those listed are the most commonly used.
Another option is to consider the use of Trusts by gifting money, ie subject to a trust, to direct how the money should be apportioned. This provides the dual advantage of; protecting vulnerable beneficiaries by looking after money and giving them only what they need and of; reducing your assets due to Inheritance Tax. The Inheritance Tax treatment depends on the type of trust that we use.
A gift into a 'bare' trust is a Potentially Exempt Transfer. This is because the eventual beneficiaries are known and fixed in advance.
A gift into a 'discretionary' trust is an immediately chargeable transfer. If the gift amount and cumulative gifts over the previous seven years exceed your Nil Rate Band for Inheritance Tax, or if you have already used up your Nil Rate Band for Inheritance Tax, then some tax will be due. The tax rate is 20% instead of 40% to the extent that the gift exceeds your Nil Rate Band.
A Discounted Gift Trust
A variation on a Gift into Trust is the Discounted Gift Trust. In this case, your bare or flexible trust cares out the right for you to receive regular payments from the plan.
In this case, the amount of the gift you make is not the same as the amount you invest. The gift, for inheritance tax purposes is less than the amount that you invest because you will receive an immediate discount upon the value. The discount is a mathematical calculation based upon life expectancy and the amount of regular payments that you are likely to receive over your lifetime. This discount represents an immediate reduction in the taxable value of your estate.
A Loan (to your) Trust
If you might need your capital back in future so you cannot give it away, you can still make use of a trust. If you can afford to give up access to the growth on your money, then you can consider lending your money to your trustees. By doing so, any growth on the value of the investment is captured outside of your inheritance taxable estate. This is really useful if your wealth already exceeds the Nil Rate Band, so it can stop the tax position from getting any worse. If your wealth is around the £2,000,000 level, then this option could be enough to ensure that you keep your residence Nil Rate Band.
The downside is that your access is restricted; if you draw back out more than you put in, then you un-do the Inheritance Tax benefits of making the loan in the first place.
You can work out how much Inheritance Tax you will owe, and take out a life insurance policy to pay that bill.
This is the simplest route to ensure that your beneficiaries receive the full value of your estate because the life assurance policy should be set up to pay out to a trust. The beneficiaries (your family?) pay the tax bill with the insurance payout then the estate can be distributed smoothly.
The insurance policy premiums should be a lot less than the payout and most policies can be set to gradually increase over time so that the sum assured keeps pace with inflation. This does make the insurance premiums go up each year, too - but you can decline the increase if you can't afford it,
Using investments that qualify for Business Property Relief
Business Property Relief was introduced in 1976 by the UK government as a way of incentivising people to invest in trading businesses. If you invest in the shares of a trading company, your investment will benefit from 100% relief from IHT providing you hold the shares for at least two years and still hold them when you pass away.
The relief only applies to unlisted shares, or shares quoted on junior stock markets like the Alternative Investment Market (AIM). Not all companies will qualify for Business Property Relief. In order for the relief to apply, a key requirement is that a company must be trading. There are investment vehicles that only invest in qualifying companies and using this option is one of the quickest ways in which to mitigate IHT.
This option might suit you if your risk profile is fairly high, or if you are considering investing an amount of money that you can afford to lose, because Business Property Relief-qualifying investments are generally higher risk.
This might also suit you if you need an Inheritance Tax solution that doesn't depend on having good health. Business Property Relief-qualifying investments 'work' (become 'qualifying' in tech-speak) after two years. That's five years sooner than most trust-based Inheritance Tax solutions, which can be important in some cases.
Mix and Match
In most of the client cases we work on, the right solution is a mix of at least two of the solutions. For example, we use life assurance to ensure that there is money available to pay the Inheritance Tax liability, and we help with Wills. That is often the foundation of our planning. Then, we work on reducing the Inheritance Tax liability. We might loan some money to a trust, to make sure that needs can be met throughout our clients' lifetimes. We might also consider a Discounted Gift Trust - for the same client - if they need an income stream, or a Gift Trust - if they don't and never will!
The options are almost endless and it’s a job we love to do.
The information within this guide if for information purposes only. It is based on our current understanding of HM Revenue & Customs guidelines. Tax and any relief from them are subject to your own individual circumstances which are subject to change.
You should seek independent professional advice before making any financial decisions. The Financial Conduct Authority does not regulate Wills, Trusts or Tax advice.