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There has been much discussion about the measures which may be introduced at the Autumn Budget on 26 November. With Rachel Reeves looking to increase tax revenue, the effect such changes will have on people's succession planning may be profound.
One of the posited changes is to the rules around lifetime gifting. A common estate planning strategy is for individuals to make gifts of their assets to reduce the size of their estates, and therefore the ultimate inheritance tax ('IHT') liability their beneficiaries will face (as long as the person making the gift survives 7 years from the date of such gift). Lifetime gifting has been a cornerstone of tax mitigation strategies used by individuals and their advisors for decades. For example, data from HMRC shows that families in the UK gave away over £2.1 billion in cash gifts in the tax year 2020/2021 to reduce the burden of IHT.
What are the current rules around lifetime gifting?
Under current rules, if you make an outright gift (called a 'potentially exempt transfer', or 'PET') to another individual and then survive it by 7 years, it will not be subject to IHT. There is no immediate tax charge when you make the gift. If you do not survive the gift by 7 years, however, the gift will need to be accounted for, and its value will be aggregated with your estate for IHT purposes.
Each estate has a Nil Rate Band ('NRB'), being the amount on which no IHT is payable, currently £325,000. Gifts you make within the 7 years before your death will eat into this allowance in priority to your estate at the date of death. Anything in excess of the NRB will usually be charged to IHT at the rate of 40%. We do not cover the Residence NRB here, but this may reduce the IHT due further.
If you have made gifts in excess of the NRB, but you survive the gifts by at least 3 years, the amount of IHT payable is reduced by taper relief. The relief is applied on a sliding scale, at a rate of 20% for each year since the gift. This means if you made the gift between 7 and 6 years before your death, only 20% of the tax due is payable (an effective rate of 8% rather than the standard 40%); between 6 and 5 years, 40% of the tax; and so on and so forth.
Another thing to be careful of is making a 'gift with reservation of benefit'. If you retain an interest in an asset you have given away, its value will remain in your estate for IHT purposes, however long it has been since the gift was made. This is a common trap people fall into when giving their homes to their children but continuing to live there rent-free.
Lifetime gifts between spouses and civil partners are exempt from IHT. The exception to this is for transfers from one spouse who is a long-term UK resident to their spouse who is not a long-term UK resident, which are only exempt up to the NRB.
Lifetime gifts to UK registered charities are also exempt from IHT. A gift to a foreign charity is not exempt, however, and would be treated as a PET.
What other exemptions are there to mitigate tax on lifetime gifts?
There are various exemptions and allowances available to apply against lifetime gifts. While some of these are objectively 'low value', they can start to add up when used consistently.
It is always possible that these exemptions might be reduced or removed in the Budget, but this is arguably unlikely for the lower value allowances.
In our experience, allowances and reliefs should be investigated and applied in the following order:
- Normal expenditure out of surplus income Lifetime gifts are immediately exempt, under current rules, if they form part of your normal expenditure out of surplus income. Surplus income is your income after tax, living expenses and usual spending (including holidays, for example) are accounted for. You must be left with sufficient income to maintain your usual standard of living. Further, gifts must be made out of income (for example a pension in drawdown) rather than capital. A regular and consistent pattern of giving must be shown, although the amounts given can vary. You might choose to give away 50% of your surplus income in monthly installments, for example, or pay your grandchild's termly school fees. There is currently no upper limit to the amount that can be given away under this exemption, and surplus income can be carried forward in certain circumstances, so it can be incredibly valuable. Nonetheless, it is not straightforward to claim, and so detailed and thorough records of annual income (including tax-free income) and expenditure, as well as gifts made, should be kept.
- Dispositions for the maintenance of your family
Payments made to a child or stepchild for their maintenance, education or training (including beyond the age of 18 if the child is in full-time education), to a relative who is deemed to be dependent on you, or to a divorced spouse or former civil partner as part of a divorce or dissolution settlement or variation of an existing settlement, are not treated as gifts at all and therefore have no IHT implications.
The exemption for dispositions for the maintenance of a dependent relative in particular can be useful, as it can cover any relative (so this could be parents, grandparents, adult children etc.), but strong evidence must be provided to HMRC that the person is incapacitated by old age or infirmity, meaning they are not capable of looking after themselves either physically or financially. - Small gifts to any one person Up to £250 can be given to any one individual during any given tax year, free of tax. The exemption is not available at all if gifts to that individual exceed £250 in that year.
- Gifts made on the occasion of a marriage or
registration of a civil partnership Gifts to either party
or to the couple jointly are exempt up to certain limits, depending
on the relationship of the donor to the couple:
- Each parent can give up to £5,000
- Each grandparent (or great-grandparent) can give up to £2,500
- Any other person can give £1,000
The gift must be made on or before the date of the ceremony and must be conditional upon the ceremony taking place.
- Annual exemption Gifts which do not qualify for any other exemption are exempt up to £3,000 per tax year. If the allowance is not (wholly) used, any remaining allowance can be carried forward to the following tax year only.
What changes have been predicted ahead of the Budget?
Some think that the 7 years may be extended to 10 years, meaning that more lifetime gifts will be brought into account on death. It is also possible that the 7-year rule could be removed altogether, meaning that all lifetime gifts will count for IHT regardless of when they were made, though this would increase the reporting burden exponentially.
Commentators have theorised that a 'lifetime gifting cap' could be introduced, abolishing PETs altogether. For example, you might only be able to give away up to £1,000,000 of assets during your lifetime free of tax. Gifts made above this cap would either be chargeable to IHT on your death, or potentially incur an immediate tax charge. Similar rules exist in the US and some European countries.
The rules around taper relief might be reviewed. If taper relief were removed entirely, then the full applicable rate of IHT would apply to all lifetime gifts in excess of £325,000 within the relevant time period (whether 7 years or longer).
What can be done to mitigate the impact of these potential changes?
For anyone who has been considering making substantive lifetime gifts, now is the time to accelerate those plans.
It is advisable to keep detailed records of any gifts made, including the intentions behind the gift; the date it was made; its value; details of the recipient; and whether it is believed any exemptions or reliefs apply. Accurate and robust records will assist in defending historic gifts against HMRC queries under any new rules. Full use should be made of the additional gifting exemptions and allowances set out above, which can help to reduce the size of your estate and may remain unchanged by the Budget.
Consideration could be given to making a loan, rather than an outright gift. This would leave open the possibility of converting the loan to an outright gift by writing it off in the future, at a time when the rules might be more generous (though it is worth noting that for as long as the loan exists, it will form part of the lender's estate for IHT purposes).
Insurance policies are available which cover the taxable term of a lifetime gift and factor in the application of taper relief. If you were to die within 7 years of making the gift, such an insurance policy would pay out to your executors to cover the remaining tax liability.
Ultimately, without a crystal ball, no one can be certain about what changes will come into force, if any. One key piece of advice we often share with clients is that in an effort to reduce future tax liability for their intended beneficiaries, they should not give so much away that they risk not having enough to live on in the future. Providing for one's own retirement and later life care should always be first and foremost in any tax planning.
Nonetheless, now is a good time to review the estate planning you currently have in place. It may be that existing plans can be adapted to include alternative structures such as discretionary trusts or family investment companies to reduce future tax burdens.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
