Making inheritance gifts from surplus income

Are you making use of this useful and much under-utilised exemption?

If you want to make inheritance gifts from surplus or excess income, there is a useful and much under-utilised exemption that allows gifts over and above the value of £3,000 per annum to be made without these gifts forming part of your estate if you die within seven years of making them.

The exemption comes under the heading of ‘Normal expenditure out of surplus income’. It is a particularly valuable way of gifting part of your estate to future generations on a regular basis.

If you want to make inheritance gifts from surplus or excess income, you need to show that you intend to make regular gifts that will not affect your normal standard of living, and that will come from income rather than capital.

This form of giving is most effective for those with higher incomes relative to their cost of living, who are either looking to clear their estate or just make gifts to loved ones – especially in order to distinguish these gifts from lifetime gifts of capital that have already been made or are being contemplated.

So, what are the requirements?

1. The gift must form part of your normal expenditure – this can mean either a pattern of regular gifts or the intention to make regular gifts. You therefore need to record when you are making a gift out of income, by writing a letter for instance.

2. The gift is made out of income.

3. You are left with enough income to maintain your normal standard of living.

In order to assess whether you have sufficient income to utilise this exemption and to satisfy conditions 2 and 3, you will need to:

Consider how much net income you receive (for example, from employment, pensions, dividends, interest, rent) after tax.

Review what your normal expenditure amounts to – there is no actual legal definition of what ‘normal expenditure’ amounts to but it is based on an individual’s particular circumstances. This may, of course, fluctuate from year to year.

Conditions that must be met

It is important to consider the conditions that must be met for gifts to qualify. The conditions of ‘surplus’ and ‘normality’ are qualitative and, without methodical planning, can leave room for doubt about the tax effects.

It’s therefore important to seek professional financial advice in advance to identify any ambiguity. Inadvertently making a gift of capital could be very costly and later give rise to a 40% Inheritance Tax charge on those funds should you die within seven years.

Carrying forward your income

If appropriate, you could complete this process each tax year to review how much surplus income you have for that year. You can then increase or decrease the amount you gift accordingly. There are no hard and fast rules as to when income no longer retains its status as income. However, HM Revenue & Customs tends to take the approach of being able to carry forward income for a period of two years.

It’s important to keep financial records that allow you to calculate and offset expenditure against income. This will determine the amount available for gifting. Tracking the opening and closing balances on monthly bank statements is the usual starting point.

Continuing to make regular payments

It’s also helpful to record a Memorandum of Intent, declaring your future intention to make regular gifts of your excess income, which can be used to anticipate a challenge to their nature. The Inheritance Tax Form 403 provides a useful record-keeping tool. Your executors will need to claim the exemption on your death, and therefore it is important to maintain thorough record keeping.

In certain situations it may be possible that a single gift could qualify so long as it can be proved upon death that there was an intention to continue with the payments. Such intention could be proved by the donor providing a signed letter to the recipient confirming their intention to continue to make regular payments.

Wishing to retain control of your capital

This is a particularly effective means of tax planning if an individual is not dependent upon such income to maintain their current standard of living but wishes to retain control of their capital. For example, a parent could pay the premiums on a life policy for their child, make payments into trust for the benefit of their children, or pay their children’s school or university fees.

The gift can be made out of general income or it could be made out of a nominated source such as property rental or specific investment income.

THIS INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF LEGISLATION. LEGISLATION AND TAX TREATMENT CAN CHANGE IN THE FUTURE. THE FINANCIAL CONDUCT AUTHORITY DOES NOT REGULATE INHERITANCE TAX PLANNING AND TRUSTS.

Inheritance Tax

Minimising the impact of inheritance tax on your estate.

The latest Inheritance Tax (IHT) statistics show an additional 4% was added to HM Revenue & Customs receipts compared to the previous year[1]. IHT is a tax payable when you die. Whether your beneficiaries have to pay it, and how much they’ll pay, is based on the value of your estate.

Your estate’s value is the value of the whole entirety of your assets. An asset is anything of value that is owned, for example; money, property, investments, businesses, possessions, payouts from life assurance not written under an appropriate trust, as well as any gifts made within seven years of your death. IHT is currently applied to estates worth more than £325,000, and will remain at this level until April 2026.

Surviving spouse

When the value of your estate exceeds this limit, known as the ‘nil-rate band’, everything over the threshold is taxed at 40% (unless you’re leaving it to your surviving spouse, in which case no IHT needs to be paid).

For the 2021/2022 tax year, there is also a ‘residence nil-rate band’ currently worth £175,000. If applicable to your particular situation, this is added to your nil-rate band of £325,000 – so your estate could be worth up to £500,000 before any IHT is payable.

Emotional times

This increased tax take suggests that the Chancellor’s freeze on the nil-rate band and residence nil-rate band at the last Budget is beginning to have the desired effect. It is achieving the ‘fiscal drag’ it set out to do, particularly given asset prices have soared following the depths of the pandemic and could continue to do so given inflation is on the up.

As a result, many more people could end up having to pay IHT without realising they would fall into the tax charge. It is vitally important people start to have conversations with loved ones to fully understand an estate and the value of it. While it isn’t always the most pleasant conversation, it is better to have it now than during more emotional times such as following a death.

Complicated tax

With the government looking for ways to plug the holes in the public finances created by the pandemic, IHT will always be in focus. IHT is a complicated tax and one that requires a necessary level of knowledge to ensure your planning in the most tax-efficient way.

So IHT planning should be a considered but it’s important not to plan in isolation – it should be part of an overall strategy that encompasses your lifetime financial goals and assets, even though constituent parts may be executed separately and at different times.

Source data:

[1] National Statistics Inheritance Tax statistics: commentary from HM Revenue & Customs
updated 29 July 2021.

INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE. THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED.

PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE. THE FINANCIAL CONDUCT AUTHORITY DOES NOT REGULATE TAXATION & TRUST ADVICE.

Creating wealth for children

Investing isn’t just a luxury reserved for adults.

Saving for a child today is a wonderful gift for their future. Whether you want to help them buy their first car, contribute to their first home or even set them up for a comfortable retirement, there is little more fulfilling than providing financial security for your children or grandchildren.

It’s worrying to think about the expenses they will face as adults. So the earlier you can start investing money for your children, the more chance it has to grow before they need it as an adult.

But, to ensure that the value of their money isn’t eroded by inflation, taxes, and fees, you’ll need to choose the right investment approach. Here are some of options you may wish to discuss with us.

Junior ISAs

A Junior Individual Savings Account (JISA) is the children’s equivalent of a regular Individual Savings Account (ISA) and works in much the same way, protecting the capital within it, and any capital growth, from Income Tax and Capital Gains Tax. You can choose between a Junior Cash ISA and a Junior Stocks & Shares ISA, or a child can have one of each.

Only a parent or guardian can open a Junior ISA on a child’s behalf, but anyone can pay into it, up to a limit of £9,000 in the current tax year (that limit may change in future tax years). The UK tax year starts on the 6th April each year and ends on the 5th April the following year. Once a child turns 16, they gain control of their ISA, but they cannot make withdrawals until they turn 18.

Junior SIPPs

A Junior Self-Invested Personal Pension (Junior SIPP) is a type of pension you can open on behalf of someone who is under 18. While we often think of a pension as a product for adult workers, opening one for a child has many benefits.

Investments in a Junior SIPP have more years to grow before the pension holder retires, and so can benefit greatly from compounding returns. If appropriate, due to the very long-term nature of the investment, it’s possible to take a higher-risk approach than with shorter-term investments, which has the potential to yield greater rewards.

As with an adult pension, all growth is protected from Income Tax and Capital Gains Tax. So, it could take away some of the burden of retirement planning as an adult. Contributions are currently capped at £2,880 a year, totalling £3,600 after tax relief is applied, in the current 2021/22 tax year.

Trusts

Trusts are a legal agreement where you – the settlor – place assets into a trust and nominate a trustee to manage those assets (whether it’s money, buildings, land or investments) on behalf of your child or children, known as the beneficiaries.

Bare trusts

A bare trust is an investment vehicle that allows you to invest capital on behalf of a child while retaining full control of the investments until the child turns 18, or 16 in Scotland.

Along with the initial capital, any return generated by a bare trust will belong to the child. It will therefore be taxed as such, usually meaning that there is less tax to pay than if the investments were held by the adult, since a child has their own personal allowances for income and capital gains.

There is no upper limit on how much can be invested each year in a bare trust.

Discretionary trusts

The main difference between a bare trust and a discretionary trust is that a bare trust is held on behalf of a specific, named individual or individuals, while a discretionary trust is held on behalf of any number of eligible individuals.

For example, a grandparent may open a discretionary trust that any of their grandchildren or future grandchildren can benefit from. Who benefits from the trust will ultimately be decided by the trustees.

The tax treatment of a discretionary trust can vary depending on your specific financial situation, so you should seek professional financial advice before opening one.

INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.

THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED.

How to future-proof your finances as a parent

A momentous event that can change every aspect of your financial stability.

The coronavirus (COVID-19) pandemic has had a shattering effect on the country. Future-proofing your finances can help you feel more secure about what lies ahead – whether that’s preparing for big life milestones, such as starting a family, or navigating difficult periods, such as unemployment or poor health.

One of the areas that tends to cause some anxiety is managing household finances with the additional cost of each child. Starting a family is one of the most momentous events in the life of a couple and it can change every aspect of your financial stability. Although you don’t need to be financially well off to start a family, it is essential that you plan and budget for it.

The estimated minimum cost of bringing up a child from birth to their 18th birthday, excluding rent and childcare costs, is £153,000 over 18 years for the child of a couple and £185,000 for the child of a lone parent[1]. The lone parent figure is higher because certain fixed costs of having children are offset by greater adult savings for the couple. Most notably in the case of transport, since the cost of having a car is offset by greater savings on public transport fares when there are two adults not one.

Whoever said the best things in life are free obviously didn’t have children. Let’s face it: kids are expensive. But, of course, they’re worth every penny. Here are some areas to consider for new parents.

Create a budget

A good first step in reducing anxiety about general expenses is to know what you’re spending. You’re less likely to be overwhelmed by a bigger-than-expected bill if you know it’s coming. If you don’t have one already, starting a budget is essential.

If you haven’t done so already, grab your calculator, bank statements and bills and draw up a household budget. Go back over the last few months and review your income (salary, overtime, benefits, and any other income sources) and spending.

Create categories for spending, such as ‘debts’, ‘bills’, ‘groceries’, ‘entertainment’, et cetera and mark them as ‘essential’ or ‘non-essential’ so you can identify any areas where you can cut back. If you’re spending more on certain categories than you expected, set a realistic goal for how much you’d like to bring that spending down.

Set financial goals

Now that you know where you stand financially, you can plan where you’d like to be in the future. Consider what you want to achieve, and then commit to it. Set SMART (specific, measureable, attainable, relevant and time-bound) goals that motivate you and write them down to make them feel tangible. Then plan the steps you must take to realise your goals, and cross off each one as you work through them.

Be specific about what’s most important to you. One of the big ‘hidden’ costs of having children may be the need for more space. For example, your highest priority might be saving for a larger home for your children to grow up in.

Or you might be saving to send your children to a particular school. Be accurate about how much you’ll need for these goals and break that down into a monthly saving schedule.

Understand your entitlements

Most people are entitled to financial support when starting a family, such as maternity and paternity pay and child benefit.

Statutory Maternity Pay is paid at 90% of your average weekly earnings for 6 weeks and then £151.97 (or 90% of your average weekly earnings if this is lower) for 33 weeks.

If you are not entitled to Statutory Maternity Pay you may be able to claim Maternity Allowance at up to £151.97 a week for 39 weeks.
If you already receive certain benefits and this is your first child, you may be entitled to a one-off payment of £500 called the Sure Start Maternity Grant.

Depending on your circumstances, you may be entitled to child benefit, tax credits, or child disability benefit.

Protect your family and lifestyle

Even if you have sufficient cash savings to cover emergencies or periods of lost income, you also need to consider different types of insurance that would pay out in these instances. You need to ensure you are properly protected should you find yourself out of work due to an accident or sickness, or if you were to die prematurely. Parents with young families need protection the most.

Parents considering cancelling insurance such as life cover or income protection as a way of saving money need to think long-term. It could have catastrophic implications on the family’s finances if either you, your spouse or partner became unable to work or were no longer around.

Income protection insurance – provides a regular income in case you are not able to work due to illness or injury.
Critical illness cover – provides a tax-free lump sum payment if you’re diagnosed with certain specified serious illnesses.
Life insurance – provides either a lump sum or regular income for your family if you’re no longer here.

Plan for retirement

Your retirement may seem a long way off and a low priority compared to the financial needs of your young family now. But it’s important to stay on track with your pension contributions through your twenties and thirties as it’s the investments you make now that have the best opportunity to grow.

Look at how much you’re contributing and obtain professional financial advice to see how much income this might provide in retirement. If you’re paying into an employers pension, a small increase in contributions might make a bigger difference than you think. Often, your contributions will be matched by your employer, and you’ll also receive tax relief, which provides an instant boost to your savings and helps the fund to grow faster than other kinds of investment.

Seek professional advice

Of all the things that cross your mind in the run up to having children, it’s fair to say that the impact on your finances will not be the thing you wish to dwell on. But how you plan to manage your money both before and after the patter of tiny feet should be a consideration once you’ve decided you’d like to start a family.

Creating a budget, choosing protection insurance, and planning for retirement can all be difficult to manage alone. Seeking professional financial advice will enable you to benefit from expert opinion and make you feel confident about your family’s finances.

Source data:
[1] Child Poverty Action Group – The Cost Of A Child In 2020 – October 2020

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email: info@iftwm.com

Month: September 2021