As we navigate through life, one question that many people wrestle with is how to pass on their wealth in a way that benefits others and leaves a lasting legacy. Traditionally, many have chosen to wait until after their death to distribute wealth to family, charities, or causes close to their hearts. However, the idea of giving while living is gaining traction, and for good reason.
Not only does it allow you to see the impact of your generosity, but there are also practical financial benefits, particularly when it comes to inheritance tax (IHT) planning. Let’s explore how you can strategically give during your lifetime, without worrying about the tax implications.
The tax benefits of giving while living
One of the most significant tax exemptions to consider is the normal expenditure out of income exemption, found in Section 21 of the Inheritance Tax Act 1984. This exemption is invaluable for IHT planners, as it allows you to make gifts that are completely free of inheritance tax, provided they meet certain criteria.
To qualify, a gift must:
1. Form part of the transferor’s normal expenditure: This means the gift is a regular part of your financial outgoings and not a one-off.
2. Be made out of income: The gift must come from your income, not capital, ensuring it doesn’t leave you financially stretched.
3. Leave you with enough income to maintain your normal standard of living: After making the gift, you must still be able to live comfortably, with your day-to-day needs covered.
When these conditions are met, the gift is exempt from IHT, regardless of whether you survive for seven years after making the gift—a rule that typically applies to most other gifts made during a lifetime.
What gifts qualify as ‘made out of income‘?
HMRC provides clear guidelines on what constitutes income when making these gifts. The following points are crucial to understand:
Capital gifts do not qualif: Gifts such as jewellery, shares, or property do not qualify for this exemption unless they were specifically purchased using income, with the intention of giving them away.
Income definition: Income, as defined by the IHT legislation, is not necessarily the same as income for income tax purposes. It refers to net income after paying income tax. Typical sources include salaries, pensions, interest, and dividends.
Income vs. Capital: If a gift is made from income that has accumulated over time, HMRC will assess whether this income has started to become capital after a certain period, typically after two years. This could complicate claims for the exemption, so it’s essential to keep records of your income and expenditure.
Accumulated income: In situations where income fluctuates, it is possible to “carry forward” unused income from previous years, but only for a limited time. HMRC tends to scrutinise cases where more than two years of accumulated income is used for gifts.
The benefits beyond the tax exemption
While the tax implications are important, there are other compelling reasons to consider giving while living. These include:
1. Seeing the impact: One of the most rewarding aspects of giving during your lifetime is the ability to see the difference it makes. Whether it’s helping a family member with their education or supporting a charity that’s close to your heart, the joy of seeing your contributions in action is truly priceless.
2. Support for loved ones: By making gifts to your family members while you are alive, you can provide them with financial support at a time when they may need it most. Whether it’s a deposit for a house, helping them with their business, or covering healthcare costs, your gifts can make a tangible impact on their lives.
3. Reduced estate complexity: Giving during your lifetime can simplify the distribution of your estate, potentially reducing the complexity and costs involved in settling your affairs after death. It can also help to ensure that your wealth is distributed in accordance with your wishes, without the need for lengthy probate processes.
Considerations before giving
While there are clear benefits to giving during your lifetime, it’s essential to approach it strategically. You should:
Assess your income: Ensure that giving won’t compromise your ability to live comfortably in retirement.
Consult with us for IHT planning: As financial planners, we can help you ensure that your gifts are structured in a way that maximises the benefits of the available tax exemptions and stays compliant with HMRC’s rules. We can guide you through the process, making sure your gifts meet the necessary criteria for exemption.
Complete the IHT403 Schedule: To document your intention when making gifts, it’s good practice to complete the IHT403 schedule. This is a crucial step in ensuring transparency with HMRC and provides a record of your gifts for IHT purposes. The schedule demonstrates your intentions and ensures that your gifts are treated correctly under the normal expenditure out of income exemption. You can find the IHT403 form here:
Keep detailed records: Accurate record-keeping is essential to ensure that your gifts meet the IHT exemption criteria.
Finally, giving while living can be one of the most rewarding decisions you make, both for your loved ones and for yourself. It provides the chance to see the positive impact of your generosity and to make significant progress with inheritance planning. By understanding the key conditions that need to be met for tax exemptions and working with us, you can structure your gifts in a way that ensures maximum benefit, both for you and your recipients.
If you’re considering giving during your lifetime, don’t hesitate to contact us. We can guide you through the process and ensure that you’re taking full advantage of the available tax exemptions, helping you leave a lasting impact.