Exempt Lifetime Gifts

The most straightforward way in which you can reduce your potential inheritance tax liability is to reduce the size of your taxable estate by making lifetime gifts. There are various exemptions which can be made use of in each tax year:

(i) The 'annual exemption' allows you to make gifts of up to £3,000 in each tax year completely free of inheritance tax. If this exemption is wholly or partly unused in any tax year, it or the balance may be carried forward to the next year. However, if it is not used in that year it will be lost.

(ii) 'Small gifts' of up to £250 can be made to any one person in any one tax year free of inheritance tax.

(iii) A parent may make a gift 'in consideration of marriage' to their children of up to £5,000 completely free of inheritance tax, grandparents may make similar gifts of up to £2,500 and any other person may make similar gifts of up to £1,000.

(iv) The other exemption is the 'normal expenditure out of income' exemption. This exemption would apply to gifts which you make if it can be shown that:

(a) the gift is made as part of your normal expenditure;

(b) the gift is made out of income; and

(c) after allowing for all such gifts made you are left with sufficient income to maintain your usual standard of living.

Whether a gift will qualify for this exemption will be a question of fact in each case.

Gifts to charities and certain other organisations are exempt from inheritance tax whether made in life or on death, regardless of the amounts involved.

'Potentially Exempt Transfers'

A gift to an individual which does not fall within any of the above exemptions will still not necessarily be subject to inheritance tax. In fact, under current rules, gifts to individuals which do not fall into another category of exemption will be treated as 'potentially exempt transfers'. This means that as long as you survive for seven years after making such a gift, no inheritance tax will need to be paid in relation to that gift.

If you die within seven years of making such a gift, the recipient may then become liable to pay some inheritance tax.  However if you make such a gift you could consider setting up a 7 year term assurance policy to pay any tax which would become payable if you died within 7 years.

Lifetime Discretionary Trusts

If you wish to potentially reduce the inheritance tax payable on your death by making a 'potentially exempt transfer', but you either want to retain some future control over the sums transferred or simply do not yet want to make an outright gift to any particular individual, you could consider setting up a lifetime 'Discretionary Trust'.

This would involve transferring a lump sum or particular assets to trustees to hold upon trust for the potential future benefit of various named beneficiaries. You (and your spouse during your lifetime) must be expressly excluded from future benefit and therefore you should only consider such a trust if you have sufficient free assets which you do not envisage requiring access to during the remainder of your life.

Another important use for Lifetime Discretionary Trusts is to set up a vehicle for tax planning in relation to significant death in service benefits or life assurance benefits.  Once such a trust has been set up (with a nominal initial trust fund, say £10) you can nominate the trustees as the persons to whom such death benefits should be paid.  This would provide a fund which your spouse (or other chosen beneficiaries) can have access to after your death, without increasing their estate(s) for inheritance tax or other purposes.

Appreciating Assets

One particular point worth noting is that if you make 'potentially exempt transfers' of assets which are likely to increase in value (whether to individuals or to a trust), if you do die within seven years of making the gift the value given to those assets for inheritance tax purposes would be the value at the time of the transfer rather than at the time of death.  This can give a lifetime gift or trust a tax advantage over a similar gift or trust contained in a Will.

Capital Gains Tax

It is important to note that before making any lifetime gifts or transfers you should consider the capital gains tax implications. There is little point in saving inheritance tax if you will incur capital gains tax, particularly bearing in mind that capital gains are effectively 'wiped out' on death.

Property given away or sold at an undervalue is treated as if transferred at full market value for capital gains tax calculation tax purposes.