Interactive Investor

‘Tis the season…to cut your inheritance tax bill

Christmas can be a great time to give your loved ones a financial leg-up in life, and trim your future tax liability in the process. Rachel Lacey explains how to do it.

19th December 2023 09:15

by Rachel Lacey from interactive investor

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Nothing says Christmas more than a tactical bit of tax planning. When it comes to things that make you feel festive, tackling your tax bill is right up there with doing the laundry or putting the bins out.

But all joking aside, if you’ve got an inheritance tax (IHT) bill brewing, Christmas gives you the perfect opportunity to bring down the value of your estate.

It is the season for giving, after all.

By giving gifts – that might perhaps be a little more generous than normal – you not only get to see your loved ones enjoying or benefiting from your wealth, you will also get the opportunity to reduce the amount of tax that will be payable when you die.

With IHT currently at a rate of 40% on assets over the threshold (the nil rate band), it’s effectively the difference between giving them £1,000 now or £600 if they inherit it after you have died.

What’s the threshold for IHT?

Currently the nil rate band for IHT is £325,000. This is the amount that you leave as an inheritance, before IHT will be charged.

However, if your estate includes a family home that is being left to your children or grandchildren, that allowance can be boosted by a further £175,000 to £500,000. This allowance, however, tapers away by £1 for every £2 your estate exceeds £2 million.

Transfers between spouses and civil partners are also free of IHT, which means that married couples, passing on a family home, can leave an estate worth £1 million before IHT will need to be paid.

Gifting rules

However philanthropic you might be feeling, you can’t just give away as much money as you want, to cut your IHT bill.

The proverbial tax man, after all, would more likely be compared to Scrooge than Santa Claus.

But so long as you stay within the rules, it’s still possible to make someone’s Christmas and take a chunk out of your estate.

Each year, there are a couple of gifting allowances you can take advantage of:

  • The annual exemption: each year you can give away up to £3,000 tax free. This can be a substantial gift to one person, or spread between a handful of people. It’s worth noting that you can also use last year’s allowance if you didn’t use it. This means that a couple, gifting for the first time, could give away as much as £12,000 this Christmas.
  • Small gifts: you can make small gifts, worth up to £250, to as many different people as you like – perfect if you’ve got lots of grandchildren. You just need to note that you can’t include anyone that has already benefited from a gift using the annual exemption rules.

If you’re going to be a guest at a wedding over the festive period, it’s also worth knowing that there are specific gifting rules for wedding presents.

You can give as much as £5,000 tax free if one of your children is getting married, £2,500 to a grandchild or grandchild, and up to £1,000 to anyone else. This could either be used to celebrate the start of married life or help them foot their wedding bill.

You can give money over and above these allowances, but whether IHT would be payable on them depends on how long you live after making the gift. These gifts are referred to as potentially exempt transfers – for them to become totally tax free, you will need to survive seven years. If you die within three to seven years, a gradually reducing rate of IHT (known as taper relief) will apply to any amount that exceeds your £325,000 nil rate band.

It’s also important to be aware that these rules apply to gifts that you have made from your capital.

You can actually give us much money as you like out of your income. The catch is that it needs to come from surplus income, so you need to be able to demonstrate that you could afford to make the Christmas gift, as part of your regular expenditure, without impacting your standard of living or raiding your savings or investment accounts.

The finishing touches

The last thing you will want is to give money away now, as part of a tax-planning endeavour, only for it to end up being taxed when you die.

For this reason, you need to think about your paper trail. And no, this doesn’t mean wrapping paper.

To ensure your gifts remain tax free, it’s always a good idea to keep a record of them; otherwise the executor of your will could get tied up in knots, working out the value of your estate and dealing with the IHT.

Your record should include the name of the recipient, the value of the gift and the date it was made.

This is particularly important when you are making gifts beyond the permitted allowances, or if you are making gifts out of income. The latter can come under particularly close scrutiny from HMRC – so in addition to the details of your gift, you will also need to provide evidence of your income and your expenditure, so that you can prove that they were affordable and that you didn’t live on beans on toast as a result.

What do I need to think about?

Gifting is the most straightforward way of cutting your IHT bill, and Christmas provides the perfect excuse to get started. It can also be particularly appealing if someone in your family is struggling financially and needs a bit of a leg-up.

However, it’s important to think about how much money you have that you can access easily, and that you don’t give away wealth that you might come to need in later life.

You should also bear in mind that once you have made your gift, you will have lost control over that money. It will be down to the recipient what they do with their windfall – which can lead to tension in some families.

If you aren’t happy to surrender control, or don’t feel comfortable giving away wealth you might later come to need, it’s worth discussing alternative ways of tackling IHT with a financial adviser.

Might IHT get scrapped?

Over the last year there has been a lot of speculation that IHT might be scrapped. Rishi Sunak has come under a lot of pressure from Tory MPs to abolish, if not reform the tax. Their calls are also being supported by the Centre for Policy Studies, which claims IHT is both unfair and excessively complicated. Instead, it suggests, capital gains tax (CGT) should be reformed.

The Autumn Statement has passed without any proposed changes to the much-hated tax, but with a general election due before the end of January 2025, IHT could feature prominently in the Tory manifesto.

However, with Labour currently holding a strong lead in the polls, it’s unlikely that the current position will change.

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