Estate Planning: Regular Gifts out of Income

There is a way to increase the amount you can give away each year without incurring a potential inheritance tax liability: Carl Lamb explains how regular gifts out of income can be used for estate planning purposes.

Making gifts to family and loved ones is a simple way to reduce your inheritance tax liability on death. However, substantial gifts that exceed your annual allowance may not be considered as having left your estate if you die within seven years of making the gift.

The gifting rules allow for each individual to give away up to a total of £3,000 each year plus any number of small gifts of up to £250 per person per year. Wedding gifts are also exempt; parents can give up to £5,000 each to the happy couple, grandparents up to £2,500 and anyone else up to £1,000. In addition, there are other gift exemptions such as gifts to charities and to political parties.

For individuals with considerable assets, these gift exemptions may not be sufficient to allow the estate to be reduced to eliminate an inheritance tax liability on their death. However, for those with surplus income - as opposed to assets - there is a further, less well-known exemption that is available to help.

Gifting out of surplus income

Regular gifts out of income are exactly what they say they are: gifts out of surplus income made by an individual on a regular basis. It all sounds easy, but there are some critical criteria that the individual must meet for the gift to qualify for the exemption.

Firstly, the donor must be able to demonstrate that a gifting pattern has been established and that he or she intends to stick to it. This doesn't mean that there has to have been multiple gifts to prove the pattern, provided that the donor can show that the intention was there to follow that pattern. It's therefore never too late to start a pattern of regular gifts, provided there is surplus income available.

Secondly, good record keeping is essential to provide evidence not only of the gifting pattern, but also to prove that the gift came from income rather than from capital. This means that the donor must be able to supply evidence of all income and expenditure incurred in the tax years in which the gifts were made. On the death of the donor, HM Revenue & Customs will certainly want to see this evidence before accepting that the gifts are exempt.

Qualifying income will be anything that counts as income on the self-assessment tax return: salary, income from self-employment or partnerships, any pension income including the state pension, rental from properties and all income from savings and investments, including dividends. What won't count as income will be any capital gains made from the sale of assets or investments or withdrawals from existing savings or holdings.

As long as the donor has the excess income available and can maintain the appropriate records, the regular gifts out of income exemption can provide an important tool for reducing clients' inheritance tax liability. The possibilities are endless: Christmas and birthday gifts, providing an annual family holiday, perhaps even insurance policy premiums or private healthcare arrangements.

Carl Lamb is managing director of Almary Green