It’s a desire most of us have and yet watching your family benefit from your wealth during your lifetime is something very few actually achieve. However as Anthony Ward from our Wealth Planning team explains, incorporating gifting into your estate planning strategy could help you achieve that elusive goal.

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Currently Inheritance tax (IHT) is paid when an individual’s estate is worth more than £325,000 (the nil rate band) when they die. The amount by which a person’s estate exceeds £325,000 is then subject to IHT at the 40% rate. However, gifts between UK domiciled spouses or civil partners (in life and on death) benefit from the IHT spouse exemption. Therefore, anything you give your spouse won’t be counted as part of your taxable estate when you die, but will be part of theirs when they die. Any unused part of your nil rate band also passes to your spouse or civil partner so that their estate will have up to £650,000 free from IHT. Gifts to anyone other than your spouse also may be a useful estate planning strategy to employ.

In addition to the above, the Government has recently announced a new allowance called the main residence nil rate band (MRNRB) which will be introduced in 2017/18. The initial MRNRB of £100,000 per person will increase to £125,000 in 2018/19, to £150,000 in 2019/20 and to £175,000 in 2020/21. This means that a house worth £ 1 million could be passed on tax free in 2020/21 (assuming there are no other chargeable assets and the individual has the benefit of both the NRBs from their pre-deceased spouse or civil partner). Note that this new exemption will not be available to larger estates – it is reduced by £1 for every £2 by which the estate exceeds £2m. The MRNB is only available on death. For more information please read the Estate Planning article in the previous editon of Wealth Features.

When is the best time to pass wealth onto the family?

Anecdotal evidence suggests that most of our clients have a will in place to ensure their assets are passed to their family, friends and chosen beneficiaries upon their death. However, there is also a growing desire to gift wealth to others during their lifetime. There are usually two reasons for this, firstly clients want to see the beneficiaries enjoy the wealth during their lifetime and secondly the gift reduces the size of the donor’s estate and could help to reduce the impact of IHT upon the donor’s death. Exempt gifts will fall outside the donor’s estate immediately for IHT purposes whilst non-exempt gifts will usually take 7 years to fall outside the donor’s estate. Certain gifts (mainly gifts to trusts and companies) can carry an immediate charge to IHT of 20% if the available NRB is exceeded.

What gifts and allowances are available?

There are a number of exemptions in place to allow gifts to be made during lifetime. The benefit of making an exempt gift is that the gift would immediately fall outside of the donor’s estate for IHT purposes. The two most common exempt gifts in our experience are:

  • The “Annual gift exemption” for gifts up to £3,000 each tax year.

    This can be carried forward for one tax year only with the current year's exemption used before any amount carried forward (a couple who have not used the exemption in the current or previous tax year could make exempt gifts of £12,000). Over a 10 year period exempt gifts of £66,000 can be made per couple.

  • The “Normal expenditure out of income exemption”

    Here gifts must form part of normal expenditure; must be made out of income; and the donor must be left with enough income to maintain their usual standard of living.

Other popular gifting strategies

In addition to using the exemptions above, gifts can be made outright to individuals or to trusts. Each of these options should be considered with a strategy based on the donor’s financial circumstances and aspirations. For example a donor could gift cash to their children with the gift being a potentially exempt transfer. This means that If the donor lives 7 years from the date of the gift then the amount gifted will be fully outside of their estate for the purposes of calculating the donor’s IHT liability; however, if the donor dies within 7 years of the gift then the amount gifted would be included in the donor’s estate when calculating the IHT payable on their death ( in some circumstances relief may be available to reduce the amount of IHT that is payable).

If the donor doesn’t wish to make an outright gift they could gift capital to a trust and retain some control over how the money will be distributed in the future by appointing themselves as a trustee. It is important to note that gifts are not effective for IHT if the donor (or their spouse or civil partner while the donor is still alive) benefits (or can benefit) from the assets they have given away. Also there can be an immediate charge to IHT of 20% if your available NRB is exceeded.

Gifting to charity either during your lifetime or on death can also be considered as a viable estate planning strategy. A gift to charity is exempt from IHT and if you give more than 10% of your estate to charity on your death, this reduces the rate of IHT on the rest of the estate.

Using exemptions to maximize your legacy

One popular way of combining gifting strategies is to gift excess income to a Trust using the normal expenditure exemption out of income discussed above (perhaps in addition to a capital gift of up to the available NRB). Let’s take a look at an example.

Jayne (age 61) and Stephen (age 64), both non-smokers, create a Trust and they appoint her brother and his sister as additional Trustees. They each have a will leaving all their assets to the survivor of the two of them on a first death. They then take out a whole of life policy that would payout on the 2nd of their deaths (as this is when the IHT would be due on their estate). The policy is held by the Trustees and Jayne and Stephen pay the premiums of £8,845 per annum1 from their excess income for the rest of their lives for a guaranteed sum assured of £1,000,000.

As they have been able to benefit from the normal expenditure out of income exemption the premiums are counted as being immediately outside of their estates for IHT purposes. They write a non-binding letter of wishes to the trustees so they understand their wishes and to provide guidance as to how they would like them to exercise their discretion when it comes to the distribution of income and capital from the trust to beneficiaries in the future. Note that, although the trustees are not legally obliged to follow the wishes which can be amended by Jayne or Stephen at any time; however, the trustees must give them careful consideration when exercising discretion.

Stephen dies at age 87 and Jayne dies at age 892 having paid premiums totaling £247,660 over the 28 year period. Upon their 2nd death the life policy in Trust pays out a guaranteed lump sum of £1,000,000. As the policy proceeds are held in the Trust they are not in Jayne’s or Stephen’s estate and IHT will not be payable. The benefit of this strategy is that they were able to fund the policy using their excess income and provide a guaranteed legacy for their family because as long as the policy’s premiums were paid the insurance company was obliged to payout the sum assured to the Trust. An additional advantage is that the pay out from the insurance policy can be used to pay the IHT on the estate (and other expenses) before a grant of probate is obtained. This can solve the issue whereby estate assets are ‘blocked’ until the IHT is paid and a grant of probate obtained. It’s important to bear in mind that the premiums on the policy must continue to be paid until the date of the second death. The policy has no surrender value if premiums are stopped before the second death.

Summary

With any estate planning strategy it is important to consider the impact of any individual action on the remainder of your financial circumstances. For example it is important to only gift assets that you can afford to lose access to and it is vital to keep accurate records of gifts made to help the executors of your estate claim exemptions when you die. Before new gifts are made previous gifts should be reviewed to establish the tax impact of any proposed gifts.

If you would like more information about Estate Planning strategies, please speak to your Private Banker who can put you in touch with a Wealth Planner.

Barclays does not give tax or legal advice. We strongly recommend that you obtain your own independent tax and legal advice tailored to your individual circumstances. In particular you should take legal and tax advice on the creation of a trust. Thereafter, you should ensure that your independent legal and tax adviser keeps you informed of any relevant changes in UK tax law and published HMRC practice.

The views expressed in this document are based on our understanding of applicable UK tax law and current HMRC practice. UK tax law, and HMRC practice, may change at any time.

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