What is “gifting from income”? 3 things to know about reducing Inheritance Tax using this method

We often publish articles about Inheritance Tax (IHT), tax-efficient gifting, and estate planning. That’s because we understand how important it is for your family’s wealth to be protected from unnecessary bills.

This is not to say that IHT is an “unnecessary” tax altogether, but rather that many families overpay it due to the absence of prior estate planning. This could lead to your beneficiaries receiving less after you pass away.

Keep reading to find out all you need to know about giving wealth away tax-efficiently in order to reduce IHT later on.

Inheritance Tax receipts are rising

According to data published by Money Marketing, IHT receipts are set to reach new highs in the 2023/24 tax year.

Between April and September 2023, HMRC received £3.9 billion in IHT alone – an increase of £400 million from the same time period in 2022.

This increase in IHT takings comes in light of the nil-rate bands being frozen until 2028. The nil-rate bands mark the amount an individual can pass down without IHT being due; we discuss these in greater depth in previous insights, which can be found on our news page.

Simply put, as the value of your estate keeps rising, more and more of your wealth may enter the taxable bracket while the nil-rate bands are frozen.

And, offering large amounts of capital to loved ones in order to reduce IHT may not be a failsafe strategy.

However, there is one gifting method that could reduce the value of your estate over time and potentially decrease the amount of IHT your loved ones pay when you die. This gifting method is technically unlimited, making it attractive to wealthy individuals who wish to mitigate IHT.

Giving funds from surplus income on a regular basis could help you reduce Inheritance Tax later

Offering annual financial gifts of more than £3,000 a year could mean that, if you were to pass away sooner than seven years after the gift was made, your family could still pay IHT on part of the gift they received.

This £3,000 gifting threshold is known as your “annual exemption” and is subject to change in future tax years. But as of 2023/24, gifts above £3,000 could still be subject to IHT if they are taken from capital, which includes:

· Savings

· Investments

· Money from selling belongings, like jewellery or cars

· Wealth received as inheritance.

Fortunately, one little-known gifting loophole is that you can offer a potentially unlimited amount of money to others without incurring an IHT liability. This can be done by using up excess income, instead of savings, investments, or other capital.

Indeed, if the money you give comes from extra income that you don’t need, rather than capital, it wouldn’t normally count towards your estate.

The following sources may count as “income” in this context:

· Pensions, including the State Pension

· Capital gains

· Dividends

· Interest earned on cash

· A salary

· Income from rental properties

· Business profits.

So, if you plan to reduce the value of your estate and help your children and grandchildren financially too, offering regular financial gifts from your income could be ideal.

3 important factors to consider if you plan to offer financial gifts from income

1. You can’t make sacrifices to your standard of living in order to offer gifts from income

The words “excess” and “surplus” form part of this gifting strategy for a reason: you can only offer this money tax-efficiently if it comes from extra income that you don’t need.

For example, if you pay for all your regular expenses and follow your usual standard of living, and you have £600 a month left over, you may normally invest or save this money for the future.

But if you already know that you have enough in your savings, investments, pensions, and property to last your lifetime, continuing to save this extra £600 a month may only add to your family’s IHT bill later.

So, instead, you may choose to give this money as a monthly financial gift to one or multiple people.

Seeing as the gift is taken from excess income, and you are not sacrificing your own standard of living to offer it, HMRC are unlikely to count these gifts as part of your estate when you die.

2. These gifts should ideally be given on a regular basis, not as a one-off

Unlike making one-off financial transfers from capital, giving financial gifts from surplus income should ideally be a regular act.

If you were to pass away after having made sporadic gifts from your income, HMRC may not recognise this as a regular gifting strategy that comes from surplus funds.

Instead, giving these gifts monthly over a period of at least three years could help demonstrate that these are affordable gifts made from income you didn’t need.

3. It may help to consult a financial planner before giving regular financial gifts

According to a freedom of information request sent by the Telegraph, published by In Your Area, in 2022 just 430 families used gifting from income as a way to reduce IHT.

While effective, this little-known gifting strategy does require a complex understanding of the government guidelines.

As such, consulting a Kellands financial planner before actioning your own regular gifting plans could be constructive. Our experts can:

· Review your finances and determine how much surplus income you have

· Advise on how much you can afford to give away

· Discuss these gifts with your intended recipients

· Create a long-term “giving while living” strategy that takes your wider circumstances into account.

To find out more about what you’ve read here, or any other estate planning matter, email us at hale@kelland.co.uk, or call 0161 929 8838.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

All contents are based on our understanding of HMRC legislation, which is subject to change.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

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