How regular gifts could be free from inheritance tax

Life has a habit of giving you the most financial freedom when you probably need it the least. In later life, you may not travel as much, start new projects or shop for luxuries. But pensions, investments and other assets have had the benefit of decades of growth. At this stage, helping the people you love may matter more. 

This is a gift in itself because it means you may be able to take advantage of the “normal expenditure out of income” exemption. Where it applies, it can allow you to make unlimited gifts that fall outside your estate immediately, rather than relying on the seven-year rule.

The amount is unlimited and tax-free on the following basis: That when HMRC assesses your claim on its individual facts, three strict conditions are met and evidenced. 

• The gifts must form part of your normal expenditure, with evidence of a settled pattern or intention to make them regularly;
• They must be made from income rather than capital;
• And they must leave you with enough income to maintain your usual standard of living. 

That’s why record keeping is critical. 

How regular gifts could save a couple £160,000 in inheritance tax

Richard and Jane are in their 70s now. They met at university and have two children together and one grandchild. Leaving a lasting legacy is their number one concern. But when they meet their financial adviser, what jumps off the pages in front of them is a larger than expected inheritance tax bill.

Richard and Jane would start making outright gifts to their family now, but for the seven-year rule. 

This is a rule that most gifts only fall outside the inheritance tax calculation if the person making them survives seven years. Richard and Jane are quite firm that having financial stress tied to their health is not the way they want to live. And the adviser understands that.

The adviser hears that Richard and Jane are very happy with a slower pace of life and already have savings ringfenced for future care costs. They receive £70,000 a year from private and state pensions, rental income and dividends, while their mortgage-free lifestyle costs around £30,000. That leaves a potential annual surplus of £40,000.

That opens the door to making gifts out of excess income, which may be a clever way to help them get around the seven-year clock. Their executors of the will (potentially their children) would need to apply to HMRC and show strong evidence of the gifts. HMRC makes decisions on a case-by-case basis, so keeping detailed records of their income, expenditure, intentions and gifts is therefore critical.

If Richard and Jane gifted £40,000 each year for ten years, £400,000 of surplus income would not accumulate in their estate. If HMRC accepts that every gift meets the exemption’s conditions, their estate remains taxable at the standard 40% rate, and the rules do not change; this could reduce their eventual inheritance tax bill by up to £160,000.

Their adviser can support record-keeping to show HMRC evidence of affordability and also do cashflow modelling to help Richard and Jane understand what they can comfortably afford to give, including the effect of future care costs or changes in income. 

How could this work for you?

If your situation sounds anything like Richard and Jane’s, Charles Stanley can help clarify your options for gifting out of excess income. Charles Stanley Financial Coaching can help you understand the key considerations and decide on your next steps.

Book a free 15-minute introductory call using the link below.