Inheritance tax planning: Use it or lose it?!

After nearly 30 years in the profession, it never ceases to amaze me how the 5 April tax year deadline catches many by surprise. As the date approaches, the financial services profession goes into overdrive, urging everyone to use their ISA, pension, and capital gains tax allowances or risk missing out. 

Following the Autumn Budget and the proposed changes to pensions and inheritance tax, it’s also now increasingly important to consider strategies to reduce any liability. With an estimated 50,000 households financially impacted by these proposals, planning could be crucial. 

Although the technical consultation period closed on 22 January, the focus seemed to be more on the practical application of the changes rather than the numbers themselves. Assuming these changes will be passed in the Finance Bill, what planning can you do to stay ahead of the curve? 

Use your exemptions! 

A quick and easy win is to use your annual gift exemption of £3,000. This exemption is per person and can be carried forward to the next tax year but only for one year. In simple terms, a couple with a liability could gift away £12,000 immediately, saving a potential £4,800 in inheritance tax. 

Gifts with a purpose  

You can help someone with their living costs without any limit and reduce your liability instantly. This could include paying rent or part of the mortgage for your child, contributing to savings accounts for someone under 18, or providing financial support to an elderly relative. The only criteria are that you can afford the payments after meeting your usual living costs and that you make the payments from your regular monthly income, which will generally be from salary, rental income, dividends, or pension income. 

If you have more than enough income to live off and plan to help your family in the future, it could result in massive tax savings by incorporating it into your regular expenditure rather than as a lump sum. In our experience, clients have felt a great sense of pride in seeing their hard-earned money help those they love. 

Surplus but no purpose 

If you regularly find that you have more income than needed to meet your expenditures, this can be gifted. As mentioned above, this should come from income sources and not capital, and we would recommend that you check with your financial planner at the outset. 

For example, if you already have enough income to meet your expenditure with a total income of £30,000, you could opt to increase your pension by £20,000. Although you would be paying 20% tax, by regularly gifting it away, it won’t be part of your estate and potentially subject to inheritance tax of 40%. 

You can look back 

If you have accumulated surplus income in the past, it will only be classed as capital after two years. You may be able to make use of unused surplus income from a previous tax year. For instance, if you had £10,000 surplus last tax year and expect this to continue, you could gift £20,000 this tax year and then £10,000 in future tax years. 

If it’s not recorded, it didn’t happen! 

As Benjamin Franklin famously said, “In this world, nothing can be said to be certain, except death and taxes.” When it comes to tax on death, HMRC wants evidence to show that the tax planning you did during your life qualifies on death. 

When using the annual exemption, you should keep the following records for the person dealing with your estate: 

• What you gave and who you gave it to. 

• The value of the gift. 

• When you gave it. 

For recording gifts from surplus income, ideally, there should be a historic pattern of 3-4 years. However, a single gift may be accepted by HMRC if there is solid evidence that it was to be the first of a series. The amounts don’t have to be identical but should be roughly similar. It is accepted that they can vary due to the unpredictable nature of income sources such as dividends. 

Thankfully, HMRC has created a suitable form, catchily named the ‘IHT403’, to help us work out what they need to see. Although intended to be used post-death, it is the ideal place for you to record gifts and makes it considerably easier for your executors when dealing with your estate. 

This blog is intended as an informative piece and should not be construed as advice.