December 13th, 2023

Could gifting from income help your clients avoid Inheritance Tax?

Last month, you read about how your clients can give tax-efficient financial gifts at Christmas.

Indeed, your clients may be especially attracted to the idea of giving some of their money to the next generation before they pass away, as they may have read that Inheritance Tax (IHT) bills are rising.

According to Money Marketing, IHT receipts are on track for “another record year”. Between April and September 2023, HMRC took £3.9 billion in IHT alone – up £400 million from the same period in 2022.

This increase in IHT takings comes as the thresholds under which no IHT is paid have been frozen. These are known as the “nil-rate bands” and have been fixed at their current rates until 2028.

So, as the value of an individual’s estate keeps rising, more and more of their wealth may be pulled into a taxable bracket.

As we covered in our previous insights, offering large amounts of capital to loved ones before they die may not help your clients to avoid IHT altogether. However, there is one gifting method that could.

Keep reading to find out how your clients could use a “gifting from income” strategy to reduce IHT down the line.

Gifting from income on a regular basis could help your clients’ families pay less Inheritance Tax later on

Offering annual financial gifts of more than £3,000 a year could mean that your clients’ families still pay IHT on a portion of this sum later. We go through exactly how this system works in our recent blog on tax-efficient gifting.

As of 2023/24, gifts above £3,000 could still be subject to IHT if they are taken from “capital”, which may include:

  • Savings
  • Investments
  • Money from selling belongings, like jewellery or cars
  • Wealth they received as inheritance.

However, one little-known gifting rule is that your clients can give a potentially unlimited amount of money away without these gifts falling into their loved ones’ IHT bracket.

If the money your clients give comes from excess income, not capital, it wouldn’t normally count towards their estate for IHT purposes.

The following sources may count as “income”:

  • Pensions, including the State Pension
  • Capital gains
  • Dividends
  • Interest earned on cash
  • A salary
  • Income from rental properties
  • Business profits.

The most crucial thing to remember here is that in order to avoid IHT with this gifting method, the gifts need to be made from surplus income. If your client is sacrificing their own standard of living to give money from their income away, this doesn’t count within the “unlimited gifting” rule.

In addition, these financial gifts should be given in a regular, settled pattern, not as a one-off.

For instance, if your client pays all their expenses and covers their lifestyle as normal, and has £500 a month left over, this £500 could be offered as a regular gift to one or several of their children.

Seeing as these funds come from excess income and are not reducing the assets your client holds, nor are your clients compromising their standard of living to share the money, these gifts are unlikely to count towards IHT later on.

If this £500 was not given as a gift each month, it might instead be placed in a savings account or invested – all of which counts as “capital”, which may then contribute towards a higher IHT bill when they pass away.

So, if your clients know they have enough to live on from their pensions, savings, and investments, they could begin giving excess income to the next generation rather than storing it away as an inheritance for later.

2 questions for your clients to ask themselves when offering financial gifts

According to a freedom of information request sent by the Telegraph, published by In Your Area, only 430 families used gifting from income as a way to reduce their IHT liability in 2022.

So, if your clients wish to utilise this little-known gifting method, here are two questions they can ask themselves before they begin offering financial gifts to their loved ones.

1. Have I sacrificed my own standard of living to offer gifts from income?

It can be difficult to measure the exact monetary value of a “sacrifice” made on behalf of a loved one. After all, it’s likely that your clients would happily live more carefully if it means they can help the next generation get on in life.

However, it’s important that your clients are still able to spend the amount they usually do each month while still being able to afford this gift.

For instance, if they cancel subscriptions, find a cheaper car loan, or eat out less often in order to accommodate the gift, this reduction of expenditure could be picked up by HMRC when they pass away.

2. Can I prove that the money I’m giving comes from income?

Secondly, it’s essential that your clients’ bank statements reflect the fact that the money they give away comes from income.

Remember, “income” can count as anything from pension withdrawals to dividends. But if your client begins drawing funds from savings or investments to keep up with regular financial gifts, these would likely count towards their £3,000 annual exemption.

Put your clients in touch with us to help them understand how gifting from income could help them reduce Inheritance Tax

HMRC’s rules around gift giving and IHT are complex. If your clients wish to begin giving surplus income to the next generation for IHT purposes, it may be wise for them to discuss these plans with a financial planner first.

We can offer further guidance around giving away funds tax-efficiently before your clients pass away, and provide reassurance about their inheritance plans.

To get started, just email or call 01905 619 100.

Please note

This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.

All contents are based on our understanding of HMRC legislation, which is subject to change.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.

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