April 2007
TAX FREE GIFTING - HOW TO AVOID THE BEAR TRAPS
Bill Saunders, head of financial planning at Acumen Financial Planning, discusses ways of avoiding the pitfalls of tax free gifting:
The Inheritance Tax (IHT) net is spread wider every year. With the value of homes in Scotland outpacing most other areas of the UK, it is a tax that will effect more and more of us, or perhaps more accurately, our children.
Even whilst we are alive, there are numerous restrictions on how much and when we can "gift" money to loved ones without it attracting the attention of the taxman. The main exemptions include:
- Husband and wife: gifts between UK domiciled spouses are exempt
- Annual exemption: Up to £3,000 per tax year per donor
- Small gifts: Up to £250 per tax year per donee
- Wedding gifts: From parents to children up to £5,000, from grandparents £2,500, and anyone else £1,000
- Gifts for education and maintenance until your child reaches 18 or finishes full time education
- Normal expenditure from income which does not reduce your usual standard of living
- Gifts to charities and political parties
IHT mitigation need not purely focus on plans effective on death. A Potentially Exempt Transfer (PET) is a transfer which is not exempt, but may become so. No tax is payable at the time of the transfer or gift, but the amount of the transfer will be brought back into account on the donor’s death if within seven years. For gifts made between three and seven years before death, a tax relief can be applied which reduces the IHT liability.
One of the most significant exemptions to IHT is ironically one of the most underused. Each of us has our own "Nil Rate Band", which broadly means that on death, the first £300,000 of our estate will not be liable to IHT, whereas the balance over and above this figure will be chargeable at 40%. So why is this exemption so often not exploited?
Let us consider an example of a married couple who have grown up children. The man dies, leaving all his worldly goods to his wife (this is the default position with the vast majority of Wills made in this country.) As noted above, no IHT is payable between husband and wife.
When the wife eventually dies however, 40% of all her assets over the Nil Rate Band will be lost to Government in taxation. The married couple have now both passed away, but only one Nil Rate Band has been used - the husband's was effectively "wasted" because all his estate was passed to his wife and was therefore exempt anyway.
If there had been sufficient available capital when the husband died, up to £300,000 could have been placed into a trust which could include the surviving spouse as a potential beneficiary. In doing so it is customary to have a Letter of Wishes so that the deceased guides his Trustees to ensure that the surviving spouse has more than sufficient assets and is totally comfortable with her financial position before opening up the Trust and passing cash, assets etc to the next generation.
It is also common for Trustees to have the power to lend the surviving spouse money from the Trust in case of need.
In the right circumstances, planning along these lines can result in tax savings of up to £120,000 (i.e. 40% of the Nil Rate Band).
As with all matters relating to estate and financial planning it is essential to seek expert advice prior to making any concrete plans.
