Estate Planning – Regular Gifts Out of Income and Pension Contributions

Helping family members financially is often a key estate planning objective and more and more clients are looking to pass on wealth during their lifetime rather than after their death.

One way of doing this is by way of regular gifts out of income. There are, however, three rules that need to be followed:

• The gift needs to come from income and not capital. Generally speaking, this will mean employment income, pension income, interest, dividends or rental income.
• The income needs to be surplus income in that making the gift will not affect your standard of living.
• The gift needs to form part of your normal expenditure and be paid on a regular basis.

By following these rules the gifts will be covered by the ‘normal expenditure out of income’ exemption meaning that they will be exempt from Inheritance Tax (IHT).

It is worth noting that it will typically be your executors or personal representatives who will need to prove to HMRC that the gifts represented regular gifts out of surplus income and the best way of doing this is to set out your income and expenditure and to regularly update this.

Pension Contributions

A particularly tax efficient way to make regular gifts out of income is to make pension contributions to a family member. This can reduce the value of your estate for Inheritance Tax purposes and the recipient can benefit from tax relief on the pension contribution.

In some circumstances it is possible to receive 90% in tax relief.

Example

Let’s take a very simplistic example and assume that Mike receives an annual income of ￡60,000 net from a Defined Benefit Pension Scheme. Mike has calculated his normal expenditure to be ￡40,000 per annum and that he can afford to make a regular gift of ￡20,000 per annum without affecting his standard of living.

Mike decides to make a contribution of ￡20,000 on behalf of his daughter, Molly, into her pension. Molly is a higher rate tax payer.

We will assume that the ￡20,000 would have been subject to Inheritance Tax so this represents a tax saving of ￡20,000 x 40% = ￡8,000.

The ￡20,000 contribution receives basic rate tax relief of 20% within Molly’s pension which amounts to ￡5,000.

As Molly is a higher rate tax payer she effectively receives a further ￡5,000 tax relief via her self-assessment tax return.

The total tax saving amounts to ￡8,000 + ￡5,000 + ￡5,000 = ￡18,000 which is 90% of the ￡20,000 contribution.

Financial Plan

Having a financial plan in place that details your assets and liabilities, your income and expenditure and sets out the value of your estate is essential to help you formulate an effective estate planning strategy.

A financial plan can help you identify how much you can afford to give away without compromising your own standard of living taking into account things such as long-term care needs.