Pension pots will fall into 40% inheritance tax net from next April, making lifetime gifting a serious option to consider, but there are potential tax traps.
Sweeping change to the treatment of pensions for inheritance tax (IHT) comes into force from April 2027 raising the spectre of a 40% tax bill and prompting more people to consider making gifts during their lifetime.
As IHT changes loom large, more people will be considering giving gifts during their lifetime to cut their tax bill. However, different gifting methods offer varying degrees of flexibility.
HMRC figures estimate that IHT will be payable on an extra 10,500 estates in the same tax year, hiking the amount of tax paid by 38,500 estates and increasing the tax due by £34,000 each on average.
One of the most effective ways to manage an IHT bill is by making gifts during your lifetime.
The annual gift allowance is £3,000 a year, which comes out of your estate immediately for IHT purposes. This allowance can be carried forward for one year. You can give up to £250 to any number of people too – although not to anyone who has received money through the annual gift allowance. You can also make specific gifts for weddings – however, the amount depends on who is getting married.
On top of that, you can give away lump sums of any kind under potentially exempt transfers (PETs), and they fall out of the estate after seven years. It is also possible to give gifts from surplus income, so once you meet your usual living expenses, you can give away income that’s left over if you do this on a regular basis.
Three things to consider before gifting
- Costs and admin involved when using trusts
Some people will consider trusts, which allow them to give something away – by putting it into the trust – but not pass it directly to the person getting the benefit. Instead, the trust is run for them by the trustees.
People will use them in order to maintain control over how the money is used, so the trust can be set up to pay for something specific. It might be set up to delay inheritance to a specific age, or it could be used to make controlled payments to the beneficiaries.
You also need to be aware of the costs involved. There could be up-front legal fees, which will depend on how complex the trust is. Then there are ongoing costs, including potential fees from professional – trustees, lawyers and accountants. There may also be tax to pay when the assets are put into the trust as well as ongoing charges. If it is a discretionary trust there may also be IHT to pay when it is set up, then every 10 years and again when the assets are given away.
If family members are used as trustees rather than professionals, this will cut the fees, but it could leave them with more work than they might expect, including everything from tax returns to investment responsibilities.
Potential trustees need to understand their responsibilities and be prepared to take them on.
But trusts remain useful tools for estate planning, and those considering using them may wish to speak with a financial adviser to ensure they understand all the conditions of any given trust before they make the decision.
- Tax risks and gift with reservation rules
Some people will give away their property to their family in the hope of getting it outside their estate after seven years have passed. However, the ‘gift with reservation of benefit’ rules mean if you continue to get any benefit from the property – such as living in it, without paying market rent – it is not counted as being given away at all for IHT purposes.
There are circumstances where a gift is given and the donor retains so much control over it that HMRC decides they have not been entirely excluded from benefiting from the property or other gift.
This may mean it falls foul of the gift with reservation rules, which are a relatively grey area.
There may be circumstances, for example, where the property is given away, but the donor doesn’t allow any redecoration during their lifetime or insists their own furniture remains in situ, when it raises the question of whether this level of control is a benefit – in which case it may not be counted as given away at all.
- Tax bill risk for the beneficiary
When someone dies, their estate is liable for IHT, however, there are exceptions to this. If they have given gifts worth up to the value of their nil rate band during the previous seven years, they are brought back into the estate on death. If they have given away more than their nil rate band, the gifts are brought back in chronological order.
Once the nil rate band is used up, IHT is paid on any subsequent gifts. Taper relief may apply, and bring the rate of tax down, but it is payable by the person who received the gift. So if a recipient were given one of these gifts and the person giving it insisted they spent it on buying something – like a property – they may be left unable to pay the bill without borrowing the cash.
As with any aspect of inheritance tax planning this is a complex area and it is recommended to seek professional advice.
Contact our specialist tax advisory and HMRC enquiry service at KKVMS.