Lifetime Giving And Estate Planning: Interaction With Inheritance Tax (IHT)

Inheritance tax is the tax that may become payable upon death should the deceased’s estate exceed the available band(s).  At the time of writing, a deceased has use of the Nil Rate Band of £325,000.00 taxed at 0%. If the deceased is also leaving property to children / grandchildren, then an additional £175k may be available and taxed at 0%. If the deceased was a widow and inherited their late spouse / civil partner’s estate, the late spouse / civil partner’s own Nil Rate Band and Residence Nil Rate Band may be available either in full or part. Following the recent budget, the aforementioned bands are currently frozen until 2028. The current rate for IHT is 40%.

Estate planning for IHT purposes

To, therefore, maximise wealth and pass it on efficiently, it is beneficial to consider estate planning and lifetime giving.

This can be achieved either via outright gifts or lifetime trusts with an accompanying will for your assets upon death.

When making lifetime gifts, each person has a total allowance of £3k per tax year which they can gift to whomever they wish to benefit. This is an exempt transfer for IHT purposes. If the £3k is not utilised in a tax year, it can be carried over for one year, totalling an exempt transfer of £6k.

It is also possible to make gifts out of surplus income, gifts below £250.00, gifts made in contemplation of marriage and to gift assets with the benefit of Business/Agricultural Property Relief. The use of the Business/Agricultural Property Relief can be beneficial in gifting such assets available under the Relief to a Non-Exempt Beneficiary to reduce some (or all) charge to IHT.

In addition, anything that passes to an Exempt Beneficiary (i.e. spouse / civil partner / charity) is exempt for IHT.

Understanding lifetime gifts

Any lifetime gift exceeding either the exempt gifts above or made to a Non-Exempt Beneficiary (i.e. anyone other than a spouse / civil partner / charity) will be deemed as a Potentially Exempt Transfer (‘PET’) for IHT.  This is ‘potentially exempt’ because the person making the gift must survive the same by seven years, for the gift not to be assessed in the estate upon their death.

If the person making the gift fails to survive the seven years this is a failed PET and may reduce either some or all of the available Nil Rate Band and cause a charge to IHT upon death. If the estate is a chargeable estate (i.e subject to IHT upon death) and the person making the gift has failed to survive for seven years, it is possible for the tax attributable to the failed PET to be tapered down accordingly.

Creating a lifetime trust

When creating a lifetime trust, an immediate charge to IHT at a rate of 20% is applicable to the amount that exceeds the available Nil Rate Band at the time. Depending on the type of lifetime trust, there will also be reporting, filing and charging obligations as well as proper administration that the appointed trustees must comply with. It is extremely important to obtain advice in relation to the creation and management of trusts prior to creating them.

Once the asset is transferred into the trust, the asset belongs to the trust.

However, when considering estate planning it is crucial to obtain advice in relation to the legal and tax implications of such planning. The current standard of living enjoyed is also to be considered to ensure that this can continue should any assets be disposed of. This is because once something is given away – it cannot be claimed back should circumstances change.

In addition, assets that are likely to increase in value should be considered for lifetime giving, as this achieves the ‘freeze’ in value at the time of the gift. When considering assets to dispose of it is important to obtain tax advice to ensure that you are compliant with any filing and/or reporting obligations placed on you by disposing of such assets. Such tax consequences may influence your decision.

It is extremely important to note that any asset that you dispose of either via gift or trust and retain a benefit in is likely to be assessed by HMRC as still being within your estate upon death. A common example is gifting the main residence / family home but continuing to use and occupy the same rent free.

It is also strongly recommended that clear records be kept at all times when making lifetime gifts to ensure that the right declarations are made to HMRC upon your death.