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I read an article recently which suggested that 35% of parents were unwilling to leave an inheritance to their children as their childrens’ spouses could eventually end up with some of the assets if there were to be a subsequent divorce. However, what about the remaining 65% of parents who would be prepared to give away their assets, despite this risk?
The benefit to those parents prepared to do so is, giving assets away during their lifetime is an effective way of mitigating any Inheritance Tax liability on their estate. It is important to remember that there is a seven year clock on such gifts which means that they remain in an individual’s estate for seven years after the date of the gift, but if they survive this period, the gift has escaped Inheritance Tax. Seven year term insurance to cover for this period is available, although the cost of this will depend upon the age and health of the donor. Of course, none of this is an issue if the individual’s estate does not exceed the nil rate tax band, which is currently £325,000, rising to £650,000 for a married couple. However, when an estate exceeds this threshold, the excess will be liable to Tax on death, at a rate of 40%.
There are a number of ways of giving assets away to your children without starting the seven year clock and the first of these is to use the individual’s annual £3,000 allowance for Inheritance Tax purposes. This enables the individual to make gifts to one or more people which total no more than this limit, each year, without any Inheritance Tax implications whatsoever. Furthermore, this allowance can be carried forward to the next tax year if unused. In addition, small gifts of up to £250 can be made to as many people as possible without affecting the estate.
A further Inheritance Tax exemption, which is often overlooked, is ‘regular gifts out of income’. Where certain conditions are satisfied, individuals can make such gifts out of post tax income and these will be exempt from Inheritance Tax. These may include annual or perhaps monthly payments to a family member. This exemption is such an important one because there is no ceiling on the amount that can be given away, as long as the income is in excess of that which is needed to continue to live a normal lifestyle. It is also important when making gifts under this exemption that records are kept of income was for the year and, of course, the amount of expenditure. This is vital because executors will be expected to report this to H M Revenue and Customs after death, but if records are kept the use of this exemption should not be underestimated.
All of these exemptions are extremely useful to help those parents who feel that they have income or assets to transfer to the next generation. However, the other issue is helping those 35% of parents who don't feel able to give away their assets and for them professional advice is a must, if their families are to benefit and not the taxman.
Graham Poles, Partner and Head of Tax
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