Inheritance tax is a looming concern for many, but there's a powerful trick that could save your loved ones from a hefty bill. Brace yourself for a surprising strategy that might just be the ultimate tax-saving move.
The number of families facing inheritance tax is on the rise. In the 2022-23 tax year, a staggering 31,500 estates paid this tax, marking a 13% increase from the previous year. And it's not just a temporary trend; the Office for Budget Responsibility predicts that by 2030, twice as many estates will be subject to this tax.
Here's the catch: inheritance tax kicks in at a rate of 40% on estates valued above £325,000. But there's a twist! If you leave your main residence to a direct descendant and your estate is worth less than £2 million, the allowance jumps to £500,000. And the cherry on top? Any assets left to a spouse or civil partner are tax-free.
But here's where it gets interesting. Savvy savers can significantly reduce their tax liability with careful planning. The secret lies in a little-known rule that allows you to gift an unlimited amount of money, completely tax-free.
The 'normal expenditure out of income exemption' rule is a game-changer. It allows you to make regular gifts from your monthly income without impacting your standard of living, and these gifts may avoid inheritance tax.
Tim Stovold, an expert from Moore Kingston Smith, explains, "This exemption is incredibly generous. There's no cap on the gift amount, and the money is instantly considered outside the estate." He adds, "It's perfect for grandparents helping with school or university fees through regular payments."
However, this rule remains underutilized, with fewer than 2,000 estates claiming it in the last four years. Chris Etherington from RSM attributes this to a lack of awareness and the rule's complexity. He says, "It requires meticulous record-keeping and planning, which can be a burden. Many without financial advisers might not even know about it, and confusion over what constitutes income may deter people from making such gifts."
To ensure HM Revenue & Customs accepts your gifts as 'normal expenditure,' maintain a consistent giving pattern. Regularity is key; give at least once a year, and consider a letter of intent or direct debit to establish a pattern if you pass away before it's fully formed. Keep the gift amounts similar; otherwise, larger gifts might not be considered 'normal.'
A crucial point to remember: the gift must come from specific income sources. It should originate from employment, pension, rental income, dividends, or savings interest, not from capital withdrawals. And the income must be received in the same tax year as the gift.
Proving the income is surplus to your needs is essential. Keep records of your living costs, as listed by HMRC, and ensure you can cover these expenses after making a gift. If you need to tap into your capital to maintain your lifestyle, HMRC might disqualify the gift.
Familiarize yourself with the IHT403 form, which executors use for gift exemptions. It provides insight into the records you should maintain and how HMRC scrutinizes income and expenses.
Tim Morris from Russell and Co warns, "A common mistake is inadequate record-keeping. Consistency in gift amounts and timing is vital, as HMRC reviews up to four years of history. Without a clear pattern, gifts might not be exempt."
So, is this the ultimate inheritance tax trick? It's a powerful strategy, but it requires careful planning and adherence to the rules. What's your take on this tax-saving technique? Do you think it's a game-changer or a potential pitfall?
