How can giving gifts reduce the liability of inheritance tax?
In a previous article, we explained how trusts can be a useful and flexible way of reducing the size of your estate and your inheritance tax liability, provided that you survive the gift to the trust by seven years and avoid any reservation of benefit. The same principles apply to outright gifts.
Outright Gifts v Trusts
Whether an outright gift or a gift to a trust is the better option for you will depend on your personal circumstances and your objectives.
Here are some of the reasons people prefer to make outright gifts:
- Simplicity. An outright gift avoids the complexity of creating and administering a trust.
- Children are ready for outright gifts. Children may be old enough and responsible enough to use the money or assets sensibly and there may be no other reasons why it would not be appropriate to give value directly to them.
- Cost. There are costs involved in creating a trust and ongoing costs in the administration of a trust. Trusts are also subject to their own tax regime. Depending on the value of the gift and the size of the recipient’s estate, it may be more cost efficient to make outright gifts rather than using a trust.
Using Gifts for Tax Planning
How can giving gifts reduce your inheritance tax?
Giving assets away reduces the size of your estate and, as a result, can reduce the inheritance tax liability on your death. The general rule is that if someone dies within seven years of making a gift, the value of the gift is still counted as part of their estate for inheritance tax purposes on their death. Usually, once someone survives making a gift by seven years, the gift is no longer relevant when calculating the inheritance tax.
A major exception to the general rule is if a gift is made with a reservation of benefit. This means that you make a gift, but still use, have the benefit of, or have an interest in the asset that you gave away.
If there is a reservation of benefit the asset is still counted as part of your estate for inheritance tax purposes until the reservation ends, at which point the seven year period begins.
Reservations of Benefit in Property
One of the most common examples of a gift with a reservation of benefit is when a parent gives their home or a share in their home to their children but continues to live in the property.
There are particular rules which apply to gifts of property and steps you can take to make sure that a reservation of benefit is avoided. These steps are fact specific but can include paying your children a rent or having them come to live with you.
However, there are risks involved in giving away a share of your property, as you lose control over the asset and circumstances could arise where you are forced to sell it. It is therefore important that you take legal advice before giving away property.
If you have any questions or would like some advice on making gifts for tax planning purposes, please get in touch with our Private Client team.