Gifting out of surplus income

My colleagues, Iain Harper and Jonathan Young, have provided some great insight to the changes from the recent budget in their articles shared over the past few weeks.

One of the biggest changes is bringing unused pension funds into the Inheritance Tax calculation from April 2027. This will impact many and will add an additional tax burden to their overall wealth. Our job as financial planners is to provide our clients with the best solutions whenever legislation changes, to ensure they can still achieve their goals, dreams, and aspirations in the most tax efficient manner.

One Inheritance Tax planning strategy that has come to the fore since the budget is the ‘regular gifts out of surplus income’ rule. This allows money gifted to your beneficiaries to be treated as being immediately outside of your estate for inheritance tax purposes. However, to qualify there are three conditions to satisfy, as follows:

• The gifts form part of your normal, habitual expenditure.
• The payments are made from income, not capital.
• Your normal standard of living is not compromised by making the gifts.

Provided the three conditions are met, this could be a useful way of drawing funds out of your pension on a regular basis and making gifts to beneficiaries without those gifts being subject to Inheritance Tax. As this is an allowance that can only be claimed on death and could be challenged, it is vital for your executors that you keep records of any gifts made under the above rules. HMRC have a form IHT 403 which allows you to do this.

It is important to stress that every client situation is unique and there are many factors to consider, including the following:

• Can you fund your own lifestyle without accessing your pension pot?
• What other assets do you hold and what is the overall size of your estate?
• What are the income tax implications of drawing from your pension to make regular gifts? Other income sources in payment such as state pension and defined benefit pension income will need to be factored into the equation.
• How much tax-free cash do you have left in your pension?
• Who do you want your pension funds to pass to on death?
• If you are over age 75, any unused pension funds passed on when you die and subsequently withdrawn by your beneficiaries, will be taxed at their marginal income tax rates.

Hopefully, this is a reminder of how important it is to have a trusted advisor in place to help you navigate changes in legislation. The rules, specifically around pensions, for those with significant assets are now so complex that having a financial planner to help you make the best decisions is essential.

To discuss any aspect of this article with a financial planner at Carbon, please contact us on 0131 220 0000 or enquiries@carbonfinancial.co.uk.

The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.

This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action.

Tax and Estate Planning Services are not regulated by the Financial Conduct Authority.