Introduction

With inheritance tax allowances largely unchanged over recent decades, and an increasing generational wealth divide, more people are considering making lifetime gifts to their children to reduce inheritance tax due on their estate and enhance the lives of the recipients.

But what are the inheritance tax implications of making these gifts, and what are the options?

Technical Summary

Generally, for a lifetime gift to leave your estate for inheritance tax purposes, you must survive seven years from the date of the gift.

However, if you do not survive the seven years, it is sometimes the recipient that will be liable for the inheritance tax due on the gift, not your estate.

Example:

• In 2020, John gifted £400,000 to his daughter Lisa. He has a substantial estate and has already made use of his annual gifting allowances.
• The first £325,000 of the gift falls within John’s available Nil Rate Band and would therefore not be subject to inheritance tax on death within 7 years (though it would mean the Nil Rate Band would not be available to use against his estate on death).
• The balance over this amount (£75,000) will remain subject to inheritance tax, but on a tapered basis as follows:

 

Years between gift and death	Rate of tax on the £75,000	Equivalent tax due on the £75,000
<3	40%	£28,000
3-4	32%	£22,400
4-5	24%	£16,800
5-6	16%	£11,200
6-7	8%	£5,600
>7	0%	£0

 

• In the event of John passing away within 7 years, Lisa, as recipient of the gift, is personally responsible for paying the above tax due to HMRC.

 

Option 1: Use the gift to pay the inheritance tax bill

Though this may seem like the simplest route, it would require Lisa to allocate a portion of her gift towards paying a potential inheritance tax bill that might arise in the seven years after receiving the gift. If John intended for Lisa to enjoy the full gift, this would not be desirable scenario.

Problems are also presented where the gift was in the form of – or was used to purchase -:

• an illiquid asset (such as property or certain types of investments) which cannot be easily sold to pay an inheritance tax bill
• an investment which had grown in value up to the point of inheritance tax being due, as there would likely be a significant tax bill on encashing the investment.

To avoid the above two scenarios, Lisa might be tempted to hold £28,000 in cash initially. However, if John did end up surviving for seven years, Lisa would have missed out on seven years of investment growth. Additionally, the interest received on this cash would likely not have outpaced inflation over the period, meaning the real value (purchasing power) of this sum will have decreased over the seven years.

 

Option 2: Defer the tax liability to John’s Personal Representatives/Executors

The circumstances in which the Personal Representatives may be liable to pay the inheritance tax on a gift (rather than the recipient) are:

Therefore, this route is not an ‘option’ as such, but a result of a recipient being unable (not unwilling) to pay the tax due.

 

Option 3: Life Insurance Policy in Trust

If John took out a life insurance policy on his own life that matched the decreasing inheritance tax liability over a term of seven years (called a Gift Inter Vivos policy), written in trust for the benefit of Lisa, it would provide the following benefits:

• Should John pass away at any point during those seven years, the life policy will pay out a tax-free sum of equivalent to the inheritance tax liability in that year which Laura can then use to settle the inheritance tax due on the gift she received.
• Lisa would be able to use the full gift amount of £400,000 for whatever she chooses as she no longer has to reserve any for a potential tax liability.
• Writing the policy into trust allows the sum assured to be paid immediately on death within the seven-year-term without having to wait for probate to be granted, and means no inheritance tax will be due on Lisa receiving the monies.
• If John pays his insurance premiums out of regular surplus income, the premiums paid will also be immediately out of John’s estate for inheritance tax purposes.

Generally the younger and healthier the life assured is, the cheaper the premiums will be for life cover.

As an example, based on a non-smoker 65-year-old male with no medical conditions, the current most competitive guaranteed premium to cover a £28,000 decreasing sum assured for seven years is £8.46 per month. In practice this would be subject to full medical underwriting which may affect the premium.

 

Summary

Gifting is a generous act which often allows people to see their loved ones benefit from an ‘early inheritance’. However it is important to ensure that there is appropriate financial planning underpinning these gifts to ensure that there are good outcomes for all involved.

 

To speak to a Financial Planner about your own inheritance tax,  tax liability and Life Insurance  please contact us on 0330 320 9280, email info@cravenstreetwealth.com or complete our online enquiry form.

The content of this article is for information only and does not constitute formal financial advice. This material is for general information only and does not constitute investment, tax, legal or other forms of advice.

You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.

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