Giving away wealth tax-efficiently

There are some important exemptions that allow you to legally pass your estate on to others, both before and after your death, without it being subject to Inheritance Tax.

Exempt beneficiaries
You can give things away to certain people and organisations without having to pay any Inheritance Tax. These gifts, which are exempt whether you make them during your lifetime or in your will, include gifts to:

– your husband, wife or civil partner, even if you’re legally separated (but not if you’ve divorced or the civil partnership has dissolved), as long as you both have a permanent home in the UK
– UK charities
– some national institutions, including national museums, universities and the National Trust
– UK political parties

But, bear in mind that gifts to your unmarried partner or a partner with whom you’ve not formed a civil partnership aren’t exempt.

Exempt gifts
Some gifts are exempt from Inheritance Tax because of the type of gift or the reason for making it. These include:

Wedding gifts/civil partnership ceremony gifts
Wedding or civil partnership ceremony gifts (to either of the couple) are exempt from Inheritance Tax up to certain amounts:

– parents can each give £5,000
– grandparents and other relatives can each give £2,500
– anyone else can give £1,000
You have to make the gift on or shortly before the date of the wedding or civil partnership ceremony. If it is called off and you still make the gift, this exemption won’t apply.

Small gifts
You can make small gifts, up to the value of £250, to as many people as you like in any one tax year (6 April to the following 5 April) without them being liable for Inheritance Tax.

But you can’t give a larger sum – £500, for example – and claim exemption for the first £250. And you can’t use this exemption with any other exemption when giving to the same person. In other words, you can’t combine a ‘small gifts exemption’ with a ‘wedding/civil partnership ceremony gift exemption’ and give one of your children £5,250 when they get married or form a civil partnership.

Annual exemption
You can give away £3,000 in each tax year without paying Inheritance Tax. You can carry forward all or any part of the £3,000 exemption you don’t use to the next year but no further. This means you could give away up to £6,000 in any one year if you hadn’t used any of your exemption from the year before.

You can’t use your ‘annual exemption’ and your ‘small gifts exemption’ together to give someone £3,250. But you can use your ‘ annual exemption’ with any other exemption, such as the ‘ wedding/civil partnership ceremony gift exemption’. So, if one of your children marries or forms a civil partnership you can give them £5,000 under the ‘wedding/civil partnership gift exemption’ and £3,000 under the ‘annual exemption’, a total of £8,000.

Gifts that are part of your normal expenditure
Any gifts you make out of your after-tax income (but not your capital) are exempt from Inheritance Tax if they’re part of your regular expenditure. This includes:

– monthly or other regular payments to someone, including gifts for Christmas, birthdays or wedding/civil partnership anniversaries

– regular premiums on a life insurance policy (for you or someone else)

It’s a good idea to keep a record of your after-tax income and your normal expenditure, including gifts you make regularly. This will show that the gifts are regular and that you have enough income to cover them and your usual day-to-day expenditure without having to draw on your capital.

Maintenance gifts
You can also make Inheritance Tax-free maintenance payments to:

– your husband or wife

– your ex-spouse or former civil partner

– relatives who are dependent on you because of old age or infirmity

– your children (including adopted children and step-children) who are under 18 or in full-time education

Potentially exempt transfers
If you, as an individual, make a gift and it isn’t covered by an exemption, it is known as a ‘potentially exempt transfer’ (PET). A PET is only free of Inheritance Tax if you live for seven years after you make the gift.

Gifts that count as a PET are gifts that you, as an individual, make to:

– another individual

– a trust for someone who is disabled

– a bereaved minor’s trust where, as the beneficiary of an Interest In Possession (IIP) trust (with an immediate entitlement following the death of the person who set up the trust), you decide to give up the right to receive anything from that trust or that right comes to an end for any other reason during your lifetime

Only ‘outright gifts’ count as PETs

If you make a gift with strings attached (technically known as a ‘gift with reservation of benefit’), it will still count as part of your estate, no matter how long you live after making it. For example, if you give your house to your children and carry on living there without paying them a full commercial rent, the value of your house will still be liable for Inheritance Tax.

In some circumstances a gift with strings attached might give rise to an Income Tax charge on the donor based on the value of the benefit they retain. In this case the donor can choose whether to pay the Income Tax or have the gift treated as a gift with reservation.

Mind the ‘pensionsg ap’

Findings from a study published in September by Aviva, in conjunction with accountants Deloitte, are a wake-up call for individuals and governments across Europe. The study concluded that the UK has the largest pensions gap per person in the whole of Europe and UK adults now need to save an average of £10,300 every year to catch up. Europe’s annual pensions gap now stands at £1.6 trillion.

The UK savings shortfall of £10,300 a year is an average based on the 31 million UK adults who are due to retire between 2011 and 2051.

Aviva warns that the problem is more acute for older people who have less time to top up their savings, especially if they intend to retire at age 65. It could also particularly affect those on lower incomes, for whom setting aside money may be more difficult.

The National Association of Pension Funds commented that ‘under-saving is a live and growing issue that will impact on more and more people as the UK ages’. Investing from an early age, even a small amount, can make a big difference in closing the gap.

ISA Surgery–don’t miss the fast-approaching deadline

An ISA is an ideal way to make the most of your tax-efficient savings limit and save for the future. The value of tax savings and eligibility to invest in an ISA will depend on individual circumstances and all tax rules may change in the future.

Your ISA questions answered

Q: Am I eligible to save or invest in an ISA?
 To save or invest in an ISA you must be:

– a UK resident
– a Crown employee (such as diplomat)
– a member of the armed forces (who is working overseas but paid by the government), including husbands, wives or civil partners
– aged over 16 years for the Cash ISA component, and over 18 years for the Stocks and Shares ISA component
– an ISA must be in your name alone; you can’t have a joint ISA.

Q: What can I save or invest in an ISA?
You can invest in two separate ISAs in any one tax year: a Cash ISA and a Stocks and Shares ISA. This can be with the same or different providers. By using a Stocks and Shares ISA, you invest in longer-term investments such as individual shares or bonds, or pooled investments.

Q: How much can I save or invest in an ISA?
In the current 2010/11 tax year, you can invest a total of £10,200 into an ISA if you are a UK resident aged 18 or over. You can save up to £5,100 in a Cash ISA or up to a maximum of £10,200 in a Stocks and Shares ISA.

Q: Do I have to pay tax on my ISA?
 An ISA is a tax-efficient investment with no personal income tax liability on any income taken from the ISA. There is no CGT on any gains within an ISA. Interest paid on uninvested cash within a Stocks and Shares ISA is subject to a 20 per cent HM Revenue & Customs flat rate charge. Interest received in a Cash ISA is tax-free. Dividends from equities are paid with a 10 per cent tax credit which cannot be reclaimed in an ISA but there is no additional tax to pay.

Q: Can I receive a tax-efficient income from my ISA?
If you hold bond funds in your ISA, the income generated would be free of income tax. This could be a real benefit if you need to take an income from your investments, perhaps as you near retirement. Even if you don’t want to invest in bonds at the moment, you may want to move money from equity funds into bonds in the future, perhaps when you need to take an income from your investments or if you want to reduce the level of risk in your portfolio as you near retirement.

Q: Do I have to mention my ISAs on my tax return?
No, you don’t have to tell the taxman about income and capital gains from ISA savings and investments.

Q: Can I transfer my existing ISA?
If you have money saved
from a previous tax year, you could transfer some or all of the money from your existing Cash ISA to a Stocks and Shares ISA without this affecting your annual ISA investment allowance. However, once you have transferred your Cash ISA to a Stocks and Shares ISA, it is not possible to transfer it back into cash.

ISAs must always be transferred; you can’t close the old ISA and start a new one in the same tax year, otherwise you will lose the tax advantage. If appropriate, you may wish to consider switching an existing Stocks and Shares ISA if you feel the returns are not competitive. But if you have a fixed-rate ISA, you should check whether you may have to pay a penalty when transferring.