Mum really does know best (on inheritance tax)
Stop the Press: David Cameron’s mother gifted him £200,000 in a possible bid to avoid inheritance tax. But what we demand to know is this: why don’t more people do the same?
The non-story of the week was the revelation that David Cameron may not have to pay inheritance tax (IHT) on a £200k gift from his mother, provided that she lives for another two years. Given that the instructions for how to do this are to be found on the HMRC website itself, this is not so much proof of tax avoidance as evidence that the PM and his mum still get on well.
Though frustrated newspaper editors have bent over backwards to report this gift-giving as a scandal, it’s not really sticking. Whatever your views on the present government, the fact is that this method of reducing IHT has been around for donkey’s years, is widely used and is publicised by the government’s own tax-collectors. In terms of tax avoidance, it’s about as controversial as opening an ISA.
If there’s anything to get worked up about, it’s this. Too many people are failing to take simple steps like this one to reduce the amount of IHT that their family have to pay. Instead, people are putting off making decisions until it’s too late – thus landing their loved ones with a big and unnecessary bill.
Inheritance: taking it step-by-step
Big IHT bills happen because of the way we tend to see inheritance: as a single, sudden event. But there’s no reason why it has to be that way. We all know we will die one day, and in later life we know the date may not be too far off. Therefore it makes financial sense to start to inheritance process when one is still alive and well, and to take a step-by-step approach.
There are a number of ways in which you can reduce the value of your taxable estate before death, and so reduce or even eliminate your IHT bill.
You can make gifts of up to £3,000 per year free of IHT (this is called your annual exemption). Wedding gifts are also exempt – up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else. You can also give up to £250 a year to anyone who has not received either of the other IHT-free gifts from you.
Donations to charities are also exempt, and (as David Cameron would be pleased to tell you) donations to political parties represented in the House of Commons.
However, small gifts like those described above may not significantly reduce the size of your estate. For gifts over the annual exemption, a special ‘seven-year rule’ applies.
Larger gifts and the seven-year rule
Any gift over the annual exemption is known as a ‘potentially exempt transfer’ (PET). If you die within three years of making such a gift, the recipient will have to pay the full 40 per cent IHT on it. There is less IHT to pay if you live longer – the amount reduces year by year from that point, falling to zero if you live for seven years or longer after making the gift. This is presumably the basis on which Mrs Cameron presumably made her gift to the Prime Minister – and anyone in a position to do so should consider doing the same.
Things to remember
Bear in mind that gifts must be genuine gifts – you cannot, for instance, put your house in your child’s name and continue to live there rent-free (or at a rent below market rate). If you continue to derive benefit from a gift, then the whole sum may still be counted as part of your estate.
Even if you do sell your home early and give the money to your children (as Ronnie Corbett did in 2003) it may not always be in their best interests. If the property were to increase signficantly in value (as often happens) then you might be better off keeping it regardless of the IHT bill.
Finally, remember that all this planning could be wasted if you don’t make and update your will. Actor and comedian Rick Mayall made the mistake of dying intestate, and intestacy law resulted in a large and totally avoidable tax liability.
For more about gift-making and other ways to minimise your
family’s IHT bill, download our free Inheritance Tax Primer Pack.
You can also discuss your inheritance needs with a financial adviser. Find yours with our smart postcode search.