Deciding whether to distribute inheritance now or leave it in a Will poses a significant dilemma for many. Immediate gifting has the advantage of providing financial support to loved ones during their lifetime, whilst the person can also enjoy seeing the benefit of the money being put to good use.

However, navigating the complexities of gifting rules can be daunting. Understanding the nuances of using gifting for estate planning is crucial, as it may introduce additional Inheritance Tax (IHT) implications for recipients down the line.

WHAT ARE THE RULES FOR MAKING GIFTS?

To start, everyone has a £3,000 annual gifting allowance per tax year, referred to as the 'annual exemption'. This allowance can be used on one person or divided among multiple individuals. Any unused annual exemption can be carried over to the following year, but only for one tax year. Additionally, smaller gifts (up to £250) can be given to as many people as desired each tax year, provided they haven't already received a gift using the £3,000 annual exemption.

However, things become more complicated with larger gifts. No tax is charged on gifts if the donor lives for seven years after making the gift (known as the ‘7 year rule'). Before reaching this milestone, the gift is considered a 'potentially exempt transfer' (PET) by HMRC. If the donor passes away within seven years of making the PET, its value is added back to their estate, potentially consuming some or all their existing IHT nil-rate band (currently £325,000). Moreover, any IHT due on the gift's value must be settled by the recipient.

If the donor passes away within the first three years of making the PET, the full 40% IHT rate is applied after utilising any nil-rate band. However, taper relief gradually reduces the IHT rate on gifts made between three and seven years before the donor's death. After a full seven years, the gift ceases to be a PET and is no longer included in the donor's estate for IHT purposes.

It is clear that planning ahead as much as possible is key to avoiding gifts outside of the annual allowances falling under the ‘PET’ umbrella.

DRAWBACKS OF GIFTING

One significant drawback to consider is that once a gift is made, it's no longer under the donor's control. This is fundamental to IHT rules. Reclaiming a gift can be challenging, which may pose difficulties if the donor requires access to it in the future for unexpected expenses like care home fees.

Lack of access to the gifted wealth can complicate matters if the donor doesn't survive the full seven years, resulting in the gift being included in their taxable estate and potentially exhausting their nil-rate band. The recipient would then be liable for any IHT due on the gift, which could pose financial challenges if the funds have already been spent.

ARE THERE ALTERNATIVE OPTIONS?

In certain cases, especially when substantial sums are involved, retaining control over assets during one's lifetime may be preferable to avoid burdening beneficiaries with an unexpected IHT bill.

Investments qualifying for Business Relief, for instance, become exempt from IHT after just two years, provided they're held at the time of death. This offers a significantly quicker path to full IHT exemption compared to the seven-year requirement for gifts.

Additionally, investments in Business Relief qualifying companies remain under the donor's ownership, allowing flexibility in accessing funds if needed. Claiming Business Relief on such investments is a straightforward process carried out by the executor of the donor's Will or the estate administrator. Ultimately, this ensures a smoother transition of assets to beneficiaries or facilitates settling any outstanding IHT obligations on the estate.

[Please remember, investments can go up and down and you may not receive back what you originally invested. We recommend always seeking advice before making investments]

This can be a really difficult decision to make, and the most suitable approach will almost certainly depend on a range of other factors. As independent financial planners, we can help you decipher the best way forward for your circumstances.

Please don’t hesitate to get in touch if you would like to arrange a relaxed chat about your situation. Call 0117 3636 212 or email office@haroldstephens.co.uk