Thinking about how to support your loved ones while also being smart with your finances?
Making gifts during your lifetime can be a great way to do both, and using your surplus income to make these gifts is a particularly useful strategy.
By regularly gifting from your surplus income, you can gradually reduce the size of your estate, potentially lowering the inheritance tax (IHT) your beneficiaries might face.
With IHT levied at a hefty 40 per cent on estates exceeding £325,000, it’s worth considering how you can make your estate more tax-efficient while providing financial support to those you care about.
Surplus income
Surplus income is the money you have left after covering all your everyday expenses—think mortgage or rent payments, utilities, food, subscriptions, and other personal outgoings.
It’s not just limited to your salary or pension either. Surplus income can also include interest from savings, dividends from investments, and rental income from properties, among other sources.
If you find you have a bit extra each month after meeting your essential needs, this surplus could be an ideal source for making gifts that could be exempt from IHT.
Making the most of surplus income gifts
Gifting from surplus income is a smart strategy for reducing IHT while supporting your loved ones. To ensure your gifts are exempt from IHT, there are three main rules to keep in mind.
Firstly, the gifts must come from your regular income, not from your savings or other capital. This means using funds from ongoing sources such as wages, dividends, or rental payments (after tax).
Additionally, these gifts should become part of your regular expenditure. So, consider setting up monthly or annual transfers to your recipients. Keep in mind one-off gifts typically won’t qualify for this exemption.
Finally, it’s important that making these gifts doesn’t impact your own standard of living. In other words, you should still be able to comfortably cover your own expenses after giving away the surplus income.
If you find yourself relying on your capital to manage your usual costs after making gifts, the exemption may no longer apply.
By following these guidelines, you can effectively use surplus income to reduce inheritance tax while providing financial support to those you care about.
How to get started with gifting from surplus income
If you’ve identified surplus income and are ready to start gifting, follow this straightforward plan to ensure everything is set up correctly:
- Take a look at your income
Begin by calculating your total income from all sources, including wages, pensions, dividends, rental payments, and interest.
Keep in mind that certain withdrawals, such as the five per cent annual allowance from an investment bond, don’t count as income for this purpose.
Accurate calculations are crucial as missteps here could lead to unexpected tax bills for your beneficiaries.
- Work out your living expenses
Take a close look at your monthly and annual expenses to determine what portion of your income is genuinely surplus.
Only consider gifting income that you can comfortably spare without affecting your lifestyle.
For instance, if your total monthly income after tax is £3,500 and your monthly expenses are £2,500, then you have a surplus of £1,000 which could be considered for gifting.
If you’re unsure about whether you have enough surplus income to make these gifts, consulting with an accountant or financial advisor can provide clarity.
- Create a regular gifting plan
Once you’re confident about your surplus income, set up regular payments to your chosen recipients.
For example, consider gifting £100 each month to a family member.
Setting up a standing order with your bank is often the easiest way to ensure consistency and avoid missing payments.
Regular payments make it clear that your gifts are part of your ongoing expenditure.
- Ensure you record all details relating to the gifts
Maintaining detailed records of your income, expenses, and gifts is essential.
HMRC may require your beneficiaries to prove that these gifts were made from your surplus income and didn’t impact your lifestyle.
Consider writing a letter of intent to the recipient, stating that the gifts are from your surplus income as this can serve as valuable evidence for HMRC after your death.
- When in doubt, seek advice from the experts
It’s wise to consult with an accountant or financial advisor to ensure your gifting strategy is both tax-efficient and compliant with HMRC guidelines.
This can help prevent potential disputes and ensure your strategy is optimally managed.
They’ll also be able to provide you with further advice on how to reduce your tax burden.
If you need guidance on gifting from your surplus income or advice on reducing your tax liabilities, our team of accountants is here to help.
Please get in touch for tailored advice and support.