The downturn has provided an unexpected upside

What many people are not aware of is that a pre-inheritance gift can still lead to a potential inheritance tax (IHT) issue. Any large, outright gifts are treated as Potentially Exempt Transfers (PETs), which means that there could still be a liability to IHT if you die within seven years of making the gift.

 

If you give away money and survive more than seven years, the full value of that PET falls outside your estate for tax purposes and, after three years, taper relief reduces the IHT payable, but otherwise it could be liable for the full 40 per cent tax charge. Therefore, if you are confident that you could manage both now and later down the line without all your assets, and want to reduce the value of your estate and help loved ones, you should make gifts as soon as possible to begin that seven-year clock. The gift also needs to be without reservation.

Careful planning should ensure that any IHT liability is reduced or potentially eliminated entirely, so calculating your current liability is a priority. IHT is payable only if the value of your estate exceeds the nil rate band for that tax year. It currently stands at £325,000 and has been frozen for the next four tax years. Any assets above this amount are taxed at 40 per cent, so an estate worth £1m would attract an IHT bill of £270,000.

Additionally, since 2007, married couples can benefit from any unused IHT allowance when one partner dies, as the unused portion of that allowance can be transferred to the survivor. This would mean that the surviving partner could have an estate worth up to £650,000, twice the current nil rate band, without having to pay IHT.
Once you’ve worked out your estate value, it’s time to consider making the most of your gift allowances. First, capital gifts of up to £3,000 per year can be made without incurring IHT. This allowance can also be carried forward for one year. Then, any number of small gifts, up to £250 per year, can be given to any number of recipients, plus gifts of £5,000 to a child and £2,500 to a grandchild as a wedding present. One of the most effective ways to use these allowances is to set up regular annual savings for your children or grandchildren, so £3,000 could be paid into an ISA or a stakeholder pension.

Finally, any gifts out of income, not capital, that are ‘regular and habitual’ are also free of IHT, so it is possible to start drawing income from investments that are currently accumulating, then give this income as surplus.