Beat the Budget: The Little-Known Trick to Passing Unlimited Wealth Tax-Free to Your Loved Ones: RACHEL RICKARD STRAUS Tells How

As Chancellor Rachel Reeves plots to take a greater share of people’s wealth when they die, a little-known trick has escaped her attention.

This allows you to pass on unlimited assets, free of inheritance tax.

It does not require complex trusts or bonds, expensive advice or administration. Unlike most other donations, you do not have to survive seven years after giving to be free of inheritance tax.

Basically all you need to set it up is a letter. Think about it and you could have it sorted before tea time today.

The exemption is known as donation from surplus income. In other words, you can pass on as much money as you want, as long as it comes from your income and not from existing assets.

Donations from regular, surplus income are tax-free and will not incur any later charges.

This way of giving could become even more valuable, with the Chancellor confirming yesterday that VAT will be added to private school fees in January.

It allows grandparents to cover the cost of their income, safe in the knowledge that their families will not pay inheritance tax if they do not survive for seven years.

Ian Dyall, head of estate planning at asset manager Evelyn Partners, says it is a ‘little known but fantastic way to pass on wealth tax-free’.

“When people first hear about it, they often think it sounds too good to be true,” he adds.

How much can you give?

You can give gifts as big or as small as you want – and to whomever you want – as long as they come from your income.

Julia Rosenbloom, tax specialist at Shakespeare Martineau, says she sees donations ranging from a few thousand to half a million pounds a year in this way.

“It can be a good way for grandparents to pay for school or university costs,” she says. ‘Or just as a gift on birthdays. The gifts should be regular.”

Rosenbloom adds that donations in this way can be a good way to ensure your estate taxes don’t increase. By donating part of your income, you prevent this from increasing your existing assets.

James Ward, partner at law firm Kingsley Napley, says he often sees the exemption being used to get children onto the property ladder or to help children who are struggling financially.

What can you give as a gift?

You can donate anything, as long as it counts as income. This includes giving your salary; an income from rental property; dividends if you own your own business; or income from your investment portfolio.

Donating interest from savings is an increasingly useful way to pass on income, says Sean McCann of asset manager NFU Mutual. “As interest rates have risen, many seniors are seeing impressive returns on their cash deposits,” he says. ‘This gives them more room to give away money.’ You do not have to donate all your excess income. If you don’t want to hand over the money right away, you can make regular donations into a trust so that they can be paid out at a later date. A tax advisor can help you set this up.

Are there rules?

To qualify for the exemption, the gift must meet three criteria.

First, it must come from income, not capital. Once you hold on to your income for a few years, the tax authorities start treating it as capital, so you must make the donation within that period. Second, it doesn’t matter how often you make a donation (for example, monthly or annually), as long as it follows a regular pattern.

Third, gifts should not affect your daily living standards.

For example, if you are someone who regularly takes global luxury cruises but stops when you start giving large amounts of money to family members, HM Revenue & Customs (HMRC) may not accept you making donations from excess income.

If you live more frugally, but don’t spend as much on nice groceries as you do on gifts, HMRC will be just as suspicious.

How do you make the gift?

You must record your intention to donate regularly. This does not have to be in the form of a legal document. You can send a letter to the recipient – ​​and keep a copy for yourself – telling him that you have decided to give him gifts on a regular basis.

To be on the safe side, you can state in the letter that you intend to make the donations because you have income that you do not need.

Although you don’t need to fill out any forms, Faye Church, from wealth manager Investec, recommends completing one just to make life easier for your executors.

On your death they will need to complete a form called IHT 403 to show that the gifts qualify for this exemption. This lists your income, expenses and donations made.

“If the information is already filled out on the correct forms, they don’t need to search your records,” Church says.

‘They may also not know that it was your intention to take advantage of this exemption, so at least write that down and keep it in a safe place, preferably with your will.’

The exemption can be used retroactively for someone, even if that was not the intention. “Some people don’t take advantage of the exemption in their lifetime because they’re not aware of it,” Ward says.

‘If the executors see that they have regularly made donations for which inheritance tax is due, they can subsequently combine their income and expenditure to show that they comply with the rules.’

Gifts must be ‘regular’ according to HMRC. But since there is no legal definition of ‘normal’ in this case, the dictionary definition can be used.

If your income varies, you don’t need to give the same size gift every time, but you should still demonstrate patterns of giving.

For example, always give your work bonuses, savings income or regularly make a gift at Christmas or birthdays.

Beware of the pitfalls…

You can’t just donate your income and live off your capital – HMRC will see right through that.

Not all investment income is eligible for the exemption.

Faye Church explains: ‘Insurance policies, lump sum cash payments or the capital element of annuities are viewed as a capital repayment rather than an income receipt.’

If you’re donating from investment income, check to see if it’s eligible so you don’t get caught.