Giving financial gifts to your loved ones while you’re still around is a great way to show you care and can also help lower your estate’s Inheritance Tax (IHT) bill.
A smart strategy is to use any extra income you have to make these gifts. Over time, this can shrink your estate’s value and reduce the IHT burden on your beneficiaries.
With IHT levied at 40 per cent on estates over £325,000, using surplus income for gifts offers a means to support your family and make your estate more tax efficient.
Surplus income is the money that’s left after you’ve paid for all your regular expenses, like rent or mortgage, utilities, food, and other everyday costs.
This doesn’t just include your salary or pension; it also covers interest from savings, dividends from investments, and rental income from property.
For instance, if you earn £4,000 a month after tax but only spend £3,000 on living expenses, your surplus income is £1,000. This surplus could potentially be used to make gifts that aren’t subject to IHT.
Gifts made from surplus income can benefit from an IHT exemption, but you need to follow these three important rules in order for it to qualify:
The first logical step is to calculate all your income sources, such as wages, pensions, dividends, and rental income.
For instance, if you earn £4,000 a month from your job, £200 from dividends, and £300 from rental properties, your total monthly income is £4,500.
Make sure to exclude certain withdrawals, like the per cent annual allowance from an investment bond, as this will not count as income for this purpose.
You need to understand your monthly and yearly expenses to ensure you’re only gifting what’s truly surplus.
You don’t want to go to all the effort of trying to ensure your loved ones are not burdened by hefty IHT liabilities just for it to turn out that the actions you took do not qualify.
If you’re uncertain about your surplus, consulting an accountant or financial advisor can provide clarity.
Maintain clear records of your income, expenses, and the gifts you make.
If HMRC asks your beneficiaries to prove that these gifts were from surplus income and didn’t affect your lifestyle.
Consider writing a letter to the recipient explaining that the gifts are from surplus income before you make the initial payment, this can serve as useful evidence for HMRC later.
Once you’ve confirmed you have extra income, set up regular payments to your chosen recipients. For example, you might set up a standing order to transfer £100 a month to your niece’s savings account.
Regular payments can be easily and quickly set up with your bank to ensure you stay consistent and don’t miss any gifts.
It’s a good idea to get advice from an accountant or financial advisor when planning to gift from surplus income to make sure you are gifting correctly.
They can help ensure your gifting strategy is both tax-efficient and compliant with HMRC rules, minimising potential issues after you’re gone.
For expert advice on gifting from your surplus income, do not hesitate to contact our accountants, who are ready to assist you.
