Passing wealth onto loved ones is an important part of financial planning for most people. Estate planning is the process of determining how and when you wish to pass your assets on. Inheritance Tax is an important consideration when it comes to Estate Planning. In the 2020/21 tax year, anything over £325,000 will potentially be taxed at 40%. If you are married or in a civil partnership, you can inherit any unused allowance and pass on a maximum of £650,000 tax free.
If you start Estate Planning early enough there are many Inheritance Tax exemptions that you can take advantage of over time. The earlier you start planning, the more time you have to gradually reduce the value of your estate and reduce or even eliminate any Inheritance Tax liability.
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Gifting from excess income is a valuable Inheritance Tax emption that is often overlooked. There is no limit on the amount that can be gifted from excess income and it is immediately exempt from any Inheritance Tax liability as long as three conditions are met:
- The gift is made out of income
- The gift does not affect the current lifestyle of the donor
- The gift is part of normal expenditure
To make use of this allowance, it is important that the gifts are regular and that you keep accurate records to prove this. It is useful to make the payments by direct debit to prove that the intention is for the gift to be regular.
What can be gifted from regular income?
Regular gifts can be used for anything you choose, including contributing to a pension, paying into a trust, sending money to your beneficiaries bank account or to regularly pay a bill or life insurance premium.
What is classified as income?
Income includes a salary if you are working, pensions, dividends, interest and rent.
Some investments that produce regular payments are not classed as income for this exemption, for example regular withdrawals from life assurance bonds. Income from an annuity purchased with funds not from your pension is also not classed as income.
If your income fluctuates annually, for example if you are a business owner, it will need to be clear that you had enough income to cover the gifts without affecting your standard of living.
What is normal expenditure?
There is no legal definition of ‘normal expenditure’ and it is often tested in court cases. For these purposes ‘normal’ is dependent on the donor’s individual circumstances.
How will my executors be able to prove the gifts were exempt from Inheritance Tax?
In order to claim the exemption, your executors need to complete the IHT 403 form. This outlines your net income and net expenditure for each year you were making gifts. This highlights the amount of surplus income after expenditure and will show whether the gifts impacted your standard of living.
It is important that you keep accurate records of your finances otherwise it will be hard to prove that the gifts are exempt from Inheritance Tax. At Four Wealth Management, a financial adviser can help you to document everything accurately.
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Contact us today to book a no-obligation financial review to discuss ways to mitigate your Inheritance Tax liability. The meeting can be at your home address or one of our offices in Bristol, London or Cirencester.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.