Inheritance tax (IHT) is a tax applied to the estate (assets, property and money) of someone who has passed away, and it can often leave families with a sizeable bill to pay.
One way to reduce the tax burden is through gifting wealth, but there are some important rules and considerations that people should be aware of before making any snap decisions, and Rebecca Williams, head of wealth planning at Brown Shipley has explained what they are.
With proper estate planning, Ms Williams said people can manage their legacy and tax affairs “most effectively”, as well as “give a head start” to the next generation.
However, she noted: “Before giving wealth away you must always make sure you have planned to secure your own financial security for the rest of your lifetime.”
As a starting point, everyone can make a gift of up to £3,000 a year to another person using their annual exemption and smaller gifts of up to £250 to any number of other people.
Ms Williams said this allows people to reduce the size of their taxable estate on death. Currently, a 40 percent inheritance tax is typically paid if a person’s estate exceeds the value of £325,000. For married couples or civil partners, it’s £650,000.
For those with children still under the age of 18, Ms Williams said: “Junior ISAs (JISAs) offer an excellent way of handing wealth on in a tax efficient manner. You can currently pay £9,000 annually into a child’s ISA, helping to build a nest egg to fund their future education, or allowing them to get a foot on the housing ladder when they’re a little older.”
“While mothers and fathers can pay into a JISA for their children, money can also be gifted by extended family and friends.”
Unlike an adult ISA, the savings cannot be touched until the child turns 18, at which point the funds can either be withdrawn or transferred into an adult ISA.
Ms Williams said: “Be aware that at 18, the money belongs to the child and they can use it as they wish.”
Another tax-efficient way of passing on wealth is the seven-year rule, which allows people to give away properties or large cash sums entirely free of tax as long as they live for seven years after the gift is made.
Ms Williams said: “If you die within seven years of making the gift, there may be inheritance tax to pay.”
In this event, the gift would be taxed at the following rates:
- If the person dies within three years of giving the gift: 40 percent
- If the person dies within three to four years: 32 percent
- If the person dies within four to five years: 24 percent
- If the person dies within five to six years: 16 percent
- If the person dies within six to seven years: Eight percent
- If the person dies after more than seven years: Zero percent.
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Delving into the seven-year gifting rules, Max Sullivan, wealth planner at Kingswood, previously told Express.co.uk : “Always, always, always keep records of any gifts you make. A simple record of when you made the gift, what it was for, and the amount should usually be enough.”
Ms Williams also explained how pensions can be utilised to reduce an IHT burden. She said: “Your pension is an excellent way of mitigating inheritance tax. Typically pensions are excluded from your taxable estate, so building a large retirement pot could be a wise estate planning tool, especially if you don’t need to draw down on it yourself.”
She added: “There are some rules to be aware of though. The amount you can contribute to your pension may be different for each person so if you’ve just had a sudden windfall, perhaps from selling a property, you can’t simply put it all into your pension pot in one go.
“Also, someone already drawing on their pension may be limited to contributions of £10,000 annually from 2023-24. If you’re not earning, then you’re limited to just £3,600 in contributions annually. This is also relevant for making pension contributions for under 18s.”
Finally, Ms Williams said that a “less well-known inheritance planning tool” is gifting out of a person’s normal expenditure.
She said: “Theoretically, it allows taxpayers to give away sums of any size – as long as they fall within their ‘normal expenditure’.”
This means gifts must be made from excess income, not savings, should not impact the person’s standard of living, and should form a regular pattern, for example monthly or annually.
Ms Williams said: “These rules are specific and can be complex and taking advice is always recommended.”
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