Gifts

Poorest person in the cemetery

Gifts are an attractive way to reduce inheritance tax, but heed the small print.

A substantial amount of money can be saved, or lost, depending on who you give it to, when you give it and, in some instances, how you give it.

If you give money to, say, a son or daughter in a rocky or failing marriage, some or all of that gift may go to their other half. Similarly, you may be throwing money down the drain by gifting it to someone who is too young to handle it wisely. A financial advisor can organise a trust so that the money is not splurged away.

If you leave money directly to a bankrupt, the bankrupt's creditors may get the dosh rather than the individual you had in mind. Again, a financial advisor can arrange alternatives so that your gift goes where you want it to go.

Over time cash (usually) erodes in value

If you insert a clause in your will specifying a gift of, say, £10,000 to someone and you die 10 or 20 years later, inflation will almost certainly reduce the value of that gift over that period. The person still gets the ten grand, but it buys less than when you wrote your will.

One way around the inflation problem is to leave, say, 10 per cent of your estate to that individual. They get one-tenth period. The value will not be diminished by inflation. If your estate has appreciated due to inflation, they enjoy that gain.

Gifts versus Trusts

By definition, a gift is something that goes from you to someone else. Possession is often said to be nine-tenths of the law, but when someone else has lawful possession, it is firmly 100 per cent. If you give it away, you no longer have it.

With a discretionary trust, you can put assets into a trust and still maintain a degree of control over how and when, and how much of it, is spent.

Heavy petting with gifts

A 'lifetime gift' is one that you give during your lifetime.

What is the alternative? One that you give on your death, via your will.

A gift to someone during your lifetime is a potentially exempt transfer - a PET - so far as IHT is concerned.

This crucial concept contains the critical term 'potential'. If you survive more than seven years after making the gift, it is tax free. Die sooner and tax may have to be paid.

The seven-year rule applies to gifts to people. Gifts to other categories - a company, a relevant property trust, an age 18 to 25 trust - are immediately chargeable.

Gifts in various guises

Gifts to a spouse/civil partner are tax-free. Exception: if the recipient is domiciled outside the UK, the tax-free exemption is limited to £55,000. If your spouse or civil partner is foreign or lived in a foreign country for a relatively long period of time, this may apply to you. A person can be ordinarily resident in England or Wales but be domiciled elsewhere.

Annual gifts ("annual exemption" in HMRC lingo) You can give gifts worth up to £3,000 in each tax year. You can also carry forward any unused part of the £3,000 exemption to the next year, but not to future years. The annual exemption is in addition to other gift exemptions.

Gifts from income HMRC's term is 'Normal expenditure out of income' and refers to gifts made purely out of income as part of a person's normal expenditure. The donor has to have enough income after the gift to maintain their normal standard of living. In addition, the gift must be part of an established gift-giving pattern.

Absolute gift An outright gift, plain and simple. The main option is a lifetime gift, which can distribute assets more to your liking except that they usually incur administration fees over a period of time.

Small gifts Small (currently £250) gifts to individuals per year are tax free. Other tax-free categories are gifts to charities, political parties and certain good causes.

Life interest A beneficiary can enjoy a benefit for the rest of their life without actually owning it. The gift can be cash, a house or land or other form of property. The key is that they do not own it outright. After their death, ownership reverts to someone else. The recipient of a life interest is a 'life tenant.'

GROBS and POATS

A 'gift with reservation of benefit' involves giving something away but retaining a benefit. Examples: you 'give' your home to someone else but continue to live in it without paying rent or paying very little (less than the open-market value); you give a painting to your son or daughter but it remains on your wall.

There are legitimate tax-efficient ways of gifting a house and continuing to live in it, but this should be done with expert professional advice. If you don't do it correctly, you or the recipient may be in for surprise income or capital gain taxes.

If a gift with reservation was made on or after 18 March 1986, the assets can be part of the estate but the seven-year limit does not apply as it does for outright gifts.

A POAT - pre-owned assets tax - arises from the Finance Act 2004 - and, as its name suggests, is aimed at individuals who give (or gave) something away, continue to enjoy benefits from the item (a home or work of art, for example), and also managed to place the item outside the estate for IHT purposes. Instead of escaping outright, the owners face income rather than inheritance tax: out of the IHT fat into the income-tax fire. "For land the benefit is calculated by reference to the rental value of the land. This is the rent that would have been payable if it had been let to the taxpayer at an annual open market rent." (HMRC)

Generous to a fault?

There are worse things than paying tax. One of them is making gifts solely to reduce inheritance tax due only to find that you need the money yourself but have given too much away.

For at least two good reasons, people of advancing age who have been generous in the gift-giving department are suddenly finding that they are older than they used to be, and also less well off.

Of the various ups and downs of life, one thing going up is life expectancy, and one thing going down (at least in 2008 up to the first part of 2009) are pensions, stocks and shares, property values, bank interest, and other items in the fallout of the recession. In short, more of us are both older and poorer.

If you give it away too soon, you may not be able to get it back. Prudence suggests that you should strike a gift-giving balance by retaining enough - even more than enough - for yourself during your lifetime. You can always give the rest of it away in your will.

Gifts to bankrupts

If you want to leave a gift to a bankrupt, you should consult a solicitor to frame the gift so that it actually helps the intended recipient.

A legacy to a bankrupt is likely to end up in the hands of the bankrupt's creditors rather than the bankrupt individual himself.