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21 December 2012 | Comment | Article by David Hulse

Tax saving the moral, legal and easy way

Inheritance Tax (IHT) is payable at 40% on all estates in excess of £325,000 (from 6 April 2009). This figure is known as the ‘nil rate band’. A married couple have a combined nil rate band of £650,000 before IHT is payable. When considering tax planning, clients often overlook the lifetime exemptions available for IHT. At first glance they may seem small, but used efficiently they can deliver quite considerable tax savings.

Exempt gifts

Some gifts made during your lifetime are exempt from IHT because of the type of gift or the reason for making it.

Gifts to exempt beneficiaries or ‘donees’

If you make a gift to the following, they are exempt for IHT:

  • your husband/wife/civil partner, as long as they have a permanent home in the UK,
  • aregistered charity,
  • amain political party.

Wedding / Civil Partnership gifts

The following gifts can be made for marriages / civil partnerships tax free:

  • parents can each give cash or gifts worth £5,000,
  • grandparents or great grandparents can give £2,500,
  • anyone else can give £1,000.

Small gifts exemption

In any tax year a person can make gifts of up to £250 to as many individuals as they wish. This is designed to cover birthday presents, Christmas gifts etc.

However, you cannot give more than £250 and claim the first £250 as small gift exemption. You also cannot use the small gifts allowance together with any other exemption when giving to the same person.

Normal gifts out of income

This can be quite a complicated one, but briefly, gifts can be exempt if made regularly out of your income. After making the payment you must be left with sufficient income to maintain your usual standard of living. In practice, these sorts of gifts are only for the relatively wealthy and HMRC will look for evidence that each gift is part of a pattern.

Annual exemption

A person can make gifts of up to £3,000 in each tax year that are exempt from income tax. The gifts are exempt from the outset; there is no need to survive by 7 years. The £3,000 can be given to one person or split between several. If the exemption is not used in on tax year, it can be carried forward to the next year, but only for one year.

Example: Mr and Mrs Jones each have a £3,000 annual exemption. If used systematically, significant sums can be passed down over relatively few years, with no need to survive for any length of time. Mr and Mrs Jones could, over 4 years, with one ‘carried forward’ year, use 10 annual exemptions. This would be a total of £30,000, with a maximum IHT saving of £12,000 on current rates of 40%.

Potentially Exempt Transfers (PETs)

All other gifts made to another individual are referred to as Potentially Exempt Transfers (PETs). They too will be exempt from IHT as long as you live for 7 years after making the gift.

However, a PET will become chargeable if the donor dies within the 7 year period. The IHT due is calculated by reference to the value transferred (not its value at the date of death) and the tax charge is calculated by reference to the rate applicable for the year of death with a reduction of the tax being given as follows:

  • transfer made between 3 and 4 years of death – 20%
  • transfer made between 4 and 5 years of death – 40%
  • transfer made between 5 and 6 years of death – 60%
  • transfer made between 6 and 7 years of death – 80%
  • transfer made 7 years or more before death – 100%

The real benefit of making a PET is that they freeze the value of the gift for IHT purposes. Even if the donor doesn’t survive by 7 years, there is the certainty that any increase in the value of the asset will escape IHT.

Example: In 2009 Bob made a gift of property worth £200,000 to his son. Bob died in 2012 by which time the value of the property had increased to £300,000. The effect of the PET is effectively to save IHT on the increase of £100,000 – a potential saving of £40,000 for IHT.

Importance of keeping records

It will help your executor or personal representative to deal with your financial affairs when you die if you keep an accurate record of any gifts you make and note what exemption/allowance you have used.

Author bio

David Hulse

Head of Hugh James Independent Financial Advisers

David Hulse heads up the Hugh James Independent Financial adviser team. An experienced adviser looking after personal and professional clients based all over the UK from London to Edinburgh and closer to home here in South Wales.

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