When it comes to tax-efficient gifting, many people overlook some of the simplest ways to save on inheritance tax (IHT). The Wealth Coach helps clients navigate these opportunities, and one often-overlooked exemption can make a significant difference.
Most of us are familiar with the annual £3,000 IHT exemption, but there’s a tax-efficient strategy that allows you to give away much more—gifts made from income.
Unlike gifts from capital (like cash or assets), which count against your IHT allowance once they exceed the £3,000 annual cap, gifts made from surplus income are fully exempt from IHT. So, what’s the catch?
To qualify for the exemption, the gift must come from income left over after covering your usual living expenses, like bills and food. This means you can’t reduce your living costs to make extra gifts out of income, and it won’t count if you use savings to support these gifts.
It’s also important to note that one-off gifts won’t typically qualify. Instead, the gift must be part of a regular, habitual pattern. While there’s no official definition of “habitual,” gifting over a three-year period is generally enough to meet the criteria.
The good news is that gifts made after the end of a tax year can still qualify for the exemption, as long as they’re within a rolling two-year period. But don’t let unspent income sit idle in your bank account, as it will be treated as capital after a couple of years, losing the IHT-exempt status.
It’s also important to keep detailed records of any gifts you make. At The Wealth Coach, we recommend sharing this information with your will’s executors so they can help prove the exemption applies in the event of your passing.
Normally, you’d need a pattern of gifts to qualify, but there’s a shortcut. By showing your intent to make regular gifts, you can jump-start this process. A simple way to do this is by writing a letter to those you plan to give to, stating that you’ll be gifting part of your surplus income annually. Alternatively, you can set up regular payments, like covering someone’s school fees or investing in a savings plan.
Starting early with your IHT planning can save you and your family significant sums, and prevent future headaches. The Wealth Coach is here to help guide you through this process and ensure you’re making the most of every opportunity.