In our previous blog, Inheritance Tax Exemptions – Christmas is a time for giving, we explained some of the main exemptions available to reduce your estate and any IHT liability it may attract. One such exemption, which is potentially the most valuable, is that of “Normal Expenditure out of Income”.
As with everything tax related, the rules can be complicated, so we will look at how this works in more detail to ensure that your loved ones benefit the most and HMRC benefits the least from your hard-earned money.
If your estate, that is to say the money, property and possessions, is below the threshold of £325,000, the transfer of your estate will be exempt from IHT. However, if your estate is above the £325,000 threshold and it is not transferred to your spouse, civil partner, a charity or a community amateur sports club, IHT may be charged at 40% on the amount above the threshold. If you fall within the latter category, you may wish to consider making Normal Expenditure out of Income to ensure the value of your estate is reduced.
Most people are aware of the “7 year rule”. That is to say you die within seven years of making a gift, the value of the gift is included in the calculation of the value of your estate and IHT may be payable on it.
However, the Normal Expenditure out of Income rules allows you to make regular gifts of any amount as long as the following three conditions are met:
- the gift formed part of your normal expenditure;
- it was made out of income; and
- it left you with enough income to maintain your normal standard of living.
Normal expenditure is not specifically defined within the legislation. However, HMRC would look at your circumstances to determine whether the expenditure is normal for you. They would also expect some form of regularity to the payment, looking for patterns, the reason or reasons for the gift, the frequency and the amounts.
A prime example of gifts which may qualify would be a monthly standing order to your grandchildren’s or even your great-grandchildren’s savings accounts.
The gifts must be made from income, so from your pension, your employment or self-employment income, rents from property, or even interest on your savings or dividend income. Gifting an asset, such as jewellery or a work of art, does not fall within this definition, unless there is proof that the asset was specifically purchased from income with the intention of making a gift. Therefore, family heirlooms will not qualify for this exemption.
It is also important detailed records are maintained to prove to HMRC gifts fall within this exemption.
As you can see, making gifts in this manner is an effective way to reduce your estate and any IHT which may be payable, as long as you plan proficiently and maintain good records. Please get in touch with the tax team if you would like help to ensure your plans meet the regulatory requirements for this exemption or if you have any questions about your specific circumstances.