If you’ve put in hard work to create wealth, it can be very frustrating to think about giving 40% of it to the taxman after you pass away.
Luckily, there are ways to transfer your wealth efficiently and tax-free while you’re still alive, with one of the best methods being to give gifts from your income. This approach lets you support your loved ones financially, decreases the total value of your taxable estate, and could help you avoid paying a lot in inheritance tax (IHT). But how does this work, and what do you need to know? Let’s simplify it further.
What Is Gifting Out of Income?
If you have extra income beyond what you need for daily expenses, you can give this surplus to family or loved ones without it being taxed as part of your estate. Unlike other gifts, which might take up to seven years to be tax-exempt, gifts from income are immediately exempt from inheritance tax (IHT).
To qualify for this exemption, follow these important rules:
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Income Source: The gift must come from your income, like wages or pension, not from your savings or investments.
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Regular Giving: It’s important to make these gifts regularly, such as monthly or annually, rather than giving large sums irregularly.
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Living Expenses: After making the gift, you should still have enough income to cover your living costs. Gifting too much could cause issues with HMRC.
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Keep Records: Maintain clear records of your income, expenses, and gifts. This documentation helps prove to HMRC that your gifts meet their requirements, especially if your estate is examined after your passing.
What Could This Look Like in Practice?
Let’s imagine you earn £100,000 per year after tax, and your annual living expenses are £60,000. This leaves you with a surplus of £40,000. You could gift all or part of this £40,000 to your children, grandchildren, or other loved ones each year.
As long as the gift meets the rules we outlined, coming from your income, being part of a regular pattern, and not impacting your standard of living, it would immediately fall outside your estate for IHT purposes. For every £10,000 you gift, you save £4,000 in potential inheritance tax.
Why Consider Gifting Out of Income?
Here are five main benefits of this strategy:
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Immediate IHT Exemption: Gifts made from income are not subject to Inheritance Tax (IHT) right away, unlike other lifetime gifts that are.
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No Maximum Limit: There is no limit on how much you can give as long as you follow the rules.
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Combine with Other Exemptions: You can add gifts from income to other allowances, such as the annual exemption of £3,000 or the small gift exemption of £250 per recipient each year, to make the most of your tax-free gifts.
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Lower Your Estate Value: Regular gifts can decrease the value of your estate, which can help you avoid or reduce IHT.
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See Your Loved Ones Benefit: The best part is being able to help your family and friends directly during your life, whether for school fees, a house deposit, or other expenses.
What Should I Do Next?
Gifting from your income is a smart and tax-friendly way to lower your inheritance tax (IHT) bill while helping those you care about. However, it requires careful planning and isn’t the same for everyone.
Before you make any gifts, talk to a financial planner. They can help you:
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Find out how much extra income you have.
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Create cash flow plans to make sure you can give gifts without sacrificing your lifestyle.
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Keep records of your gifts that meet HMRC requirements.
Estate planning can seem complicated, but with the right advice, you can manage your legacy and ensure that more of your wealth goes to your loved ones instead of HMRC.