Leave your Money where your Heart is – the Value of Lifetime Gifts


The Inheritance Tax (IHT) nil rate band is set at £325,000 until 5 April 2015. With certain exceptions the value of an estate above this will be taxed at 40%. Given this tax rate and the fact that most of us would prefer that our worldly goods pass to our loved ones rather than the Chancellor, it is important to plan for IHT in good time.

There are a number of ways in which the effect of IHT on an estate can be saved, one of which is to make yourself poorer by making lifetime gifts. Remember, however, that in considering the IHT benefits of lifetime gifts, it is important not to lose sight of the fact that such gifts may be deemed disposals for Capital Gains Tax purposes.

As far as IHT is concerned lifetime transfers fall into three categories:

1. chargeable transfers;

2. potentially exempt transfers (PETs); and

3. exempt transfers.

Chargeable transfers are any lifetime transfers which are neither PETs nor exempt transfers.

PETs are transfers from one person to another which do not fall into any of the exempt categories which are mentioned below. No IHT is charged when the PET is made and it is treated as exempt unless the transferor dies within seven years, in which case it is chargeable to IHT at its value when made. PETs are a very useful way of saving IHT as they allow you to gift as much as you like subject to your survival for seven years. After three years any tax liability is reduced by taper relief. Insurance is usually available should you not survive as long as necessary. If a PET is to be made, it is best to consider making a significant transfer. For example, if £1,000,000 were available to transfer as a PET, it would be worth transferring the whole sum rather than a lesser some of say £400,000. This is because the lesser sum uses up one’s entire nil rate band in the same way as a gift of £1,000,000.

Here we will focus on exempt transfers, which unlike PETs are exempt when made and remain so, regardless of whether or not the person making them dies within seven years. Importantly they will not use up any of the transferor’s nil rate band.

The most obvious exempt transfer category is that of normal expenditure out of income. In order to fall into this category, transfers of value must be made as part of the habitual expenditure of the transferor out of their income and leave sufficient funds for them to maintain their usual standard of living. A person could therefore take the decision to live relatively extravagantly and run down their assets, although an attempt to spend everything at the last minute might well come in for scrutiny by HMRC. More usually this exemption can be employed to cover the payment of premiums on a life policy, which could be written in trust for a non-exempt beneficiary.

One of the advantages of marriage or civil partnership is that lifetime transfers between spouses or civil partners are exempt from IHT, so long as the gift is outright. This means that lifetime gifts to a trust of which the spouse is a beneficiary are not exempt. This exemption can be useful where spouses have estates of unequal value although, if the estate were to go to the spouse on death anyway, that spouse would receive it free of tax and have the benefit of the transferable nil rate band. This exemption ceases to apply on divorce.

In addition, we can all take advantage of our annual exemption. This allows exempt transfers of value in any one tax year up to an aggregate total of £3,000. If gifts exceed £3,000, only the excess is not exempt and will therefore be a PET or chargeable transfer. In common with all IHT exemptions and reliefs, each spouse or civil partner has their own annual exemption, which if not fully used in any one tax year can be carried forward to the next year, but no further.

You can also make any number of outright gifts of less than £250 to different people in a each tax year. The sum of £250 should not be exceeded or the whole gift will become either a PET or chargeable transfer. For example: a grandmother could give £250 exempt from IHT to each of five grandchildren every year, despite having used up her annual exemption. If, however, she decided to give each £500, the gifts would not be exempt.
Further exempt transfers may be made as gifts in consideration of marriage. These gifts may be up to £5,000 in respect of one marriage if the transferor is a parent, £2,500 if the transferor is a “remoter ancestor” (ie. aunt, uncle, grandparents etc.) and £1,000 in all other cases. The gift must be outright to a party to the marriage or to a trust the primary beneficiaries of which are the parties or their children. Where the limit is exceeded, only the excess is not exempt.

Lifetime transfers made to charities, housing associations, for “national purposes”, the public benefit or to political parties are also exempt.

In IHT planning it is essential therefore to consider the advantages of making lifetime gifts to ensure that your intended beneficiaries gain the maximum value from your estate.

Gordon Dadds