Simple way your loved ones can pass their wealth to you and avoid paying tax
If you want to one day pass on your wealth to loved ones without paying tax, you may want to take a look at this simple trick.
The tax exemption is referred to as gifting out of surplus income - meaning you can pass on unlimited money which comes from your own income, instead of existing assets. These are not like other gifts which are subject to the seven-year rule - wherein gifts can be subject to inheritance tax if they are given within seven years of your death.
These particular types of gifts - made from surplus income - are tax-free. Personal wealth expert Ian Dyall says: “Gifting out of income is a little-known, but fantastic way of passing on wealth tax-free. When people first hear about it, they often think it sounds too good to be true.” Sean McCann of NFU Mutual describes it as the “most powerful but least known exemption”.
You are permitted to make gifts as large as you like as long as they are made out of your own income. Tax specialist at Shakespeare Martineau Julia Rosenbloom says she has seen gifts of up to half a million made in this way. “It can be a good way for grandparents to pay towards school or university fees,” she explains. “Or just for gifts on birthdays. The key is the gifts must be regular.”
By gifting some income you prevent it from adding to your existing assets, Rosenbloom explains - therefore gifting can prevent your inheritance tax liability from growing. Law firm partner at Kingsley Napley James Ward says the exemption is used to help children get on the property ladder - or if they are financially struggling.
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What exactly am I allowed to gift someone?
Anything which counts as income can be gifted, including salary, dividends if you own a company, or income from investments, report MailOnline. But to gift from an investment income may require an adjustment of your portfolio, such as “investing in products that provide a higher level of income according to investment expert Faye Church.
The gift must fulfil three criteria. Firstly, it must come from income as opposed to capital - income which has been unspent for a couple of years will start being treated as capital by the taxman, so there is a certain timeframe within which gifts must be made.
Secondly, it doesn’t matter how often the gift is made but it must follow a regular pattern, whether it be monthly or annually. Finally, the gifts must not affect your personal everyday standard of living.
So, for example, if you are wealthy and regularly splash out money on a holiday every few months, and then stop doing so when you begin giving big sums to family members HMRC is unlikely to accept that you are gifting out of ‘surplus income’. If you are more frugal but stop allowing yourself to splash out on nice food at your grocery shop when you begin gifting money, their response may be the same.
You must record your intention to gift - but only with a simple letter to the recipient to inform them you will make them regular gifts. For clarity, you should state in the letter that you are making the gifts because you have surplus income which you don’t need for yourself.
The exemption can also be used retrospectively. Ward tells the MailOnline: “Some people don't use the exemption in their lifetime because they are unaware of it. However, if the executors see that they made regular gifts that would be liable for inheritance tax, they could retrospectively piece together their income and expenditure to show it met the rules.”
However…
You can’t gift all of your income and live off your capital - HMRC will see what you are doing. You also may not want to gift from a pension income - because pensions can be passed on free from inheritance tax if you pass away before 75 and only become subject to tax for the beneficiary if you are older.
“So keeping your money in a pension wrapper may be more effective than drawing and gifting it out of regular income,” Ward says.
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