Pass on unlimited wealth to your loved ones TAX FREE

There’s a little-known trick that allows you to pass on unlimited assets to your loved ones, without inheritance taxes.

It does not require complex trusts or bonds, expensive advice or endless administration. Basically all you need to set it up is a letter.

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.

Unlike most other gifts, gifts made in this way are not subject to the seven-year rule, where gifts may be subject to inheritance tax if you die within seven years of the gift.

Donations from regular, surplus income are immediately tax-free and do not cause a bill later.

Ian Dyall, head of estate planning at asset manager Evelyn Partners, said: ‘Gifting income 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.’

Sean McCann, of asset manager NFU Mutual, agrees that many more people could benefit from the relief than currently do.

“It’s the most powerful but least known exception,” he says. “People just don’t realize the power of it.”

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 key is that the gifts must be regular.”

Rosenbloom adds that donations in this way can be a good way to ensure that your estate taxes do not increase further. This is because by donating part of your income, you prevent it from being added to 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 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 have your own business; or income from your investment portfolio.

If you want to give from your investment income, you may want to adjust your portfolio to include assets that prioritize income disposal rather than growth.

Faye Church, a senior financial planner at investment manager Investec Wealth & Investment, said: ‘We are helping clients who want to take advantage of this relief by looking at structuring their investment portfolios to invest in higher-yielding assets.

‘For example, investing in products that provide a higher level of income, such as shares that pay a higher dividend, or higher-yielding government bonds and bonds.’

Donating interest from savings is also an increasingly useful way to pass on income, says Sean McCann. “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. And if you don’t want to hand over the money right away, you can make regular donations into a trust, which will be distributed at a later date. A tax advisor can help you set this up.

What are the 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. And third, the gifts should not affect your daily living standards.

What this means will vary from person to person. In other words, if you are someone who regularly goes on luxury cruises around the world, but stops when you start giving large amounts of money to family members, HM Revenue & Customs may not accept you donating from excess income.

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

How do you do it?

You must record your intention to donate regularly. However, this does not have to be in the form of a legal document. You can simply 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 have to fill out any forms, Investec’s Faye Church recommends that you complete one, just to make your executors’ lives easier.

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

“Completing these forms yourself will help your executors tremendously,” says Church. ‘If the information is already filled out on the correct forms, they don’t have to go through your records.

‘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.’

However, 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.

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

The gifts given must be ‘regular’ according to HM Revenue & Customs. However, as there is no legal definition of ‘regular’ in this case, the dictionary definition can be used.

If your income varies, you don’t have to give the same size gift every time, but you should show a regular pattern of giving.

Consider, for example, always donating your work bonuses, savings income or regularly giving a gift at Christmas or on birthdays.

Setting your intention to give regularly is crucial, Church explains. “There was one case that went to trial where a woman made one gift and died before she could make a second one. ‘However, because she had expressed the intention to make regular donations, the first donation qualified for the exemption because it was treated as an ordinary donation.’

Outlining your intentions can also help if the size of the gift changes. For example, in another case, a woman had written down her plans to give away the family business’s dividend income at the end of each year.

“Initially the size of the gifts was only several thousand pounds,” says Dyall. ‘But then the company was bought out and dividend payments went through the roof.

‘The woman paid the higher amount once and then died. However, the court accepted that the gift followed a regular pattern – even if it was many times more generous than the previous one – because she had set out her methodology and stuck to it.”

Who is it useful for?

While a growing number of estates are subject to inheritance tax, only about six percent currently receive a bill.

If the value of your assets is less than the inheritance tax-free allowance of £325,000, you will not have to pay a bill on your death. Couples can combine their allowances to give away £650,000 tax-free.

And if you pass on a family home to direct descendants, a couple can pass on a property worth up to £1 million tax-free.

However, if your estate is worth more than your allowances and you want to reduce the amount you donate to the state, there are other donation rules you can take advantage of.

Donating from a fixed income is a good option if you have a high income and more modest expenses. However, if you need your income for your own expenses, there are other allowances that allow you to donate capital.

For example, you can give away assets or cash up to a total of £3,000 in a tax year without this being added to the value of your estate for inheritance tax purposes.

You can also give up to £5,000 to a child on the occasion of his or her wedding, or up to £2,500 to a grandchild, or up to £1,000 to another family member or friend.

Also remember that married couples and civil partners can pass their estate on to their spouse tax-free upon death.

Be careful, there are pitfalls…

You can’t just donate your income and live off your capital – HM Revenue & Customs will see right through that. Secondly, donating pension income may not always be beneficial, warns James Ward of law firm Kingsley Napley.

Pensions can be passed on free of inheritance tax if you die before the age of 75, and are only taxable to the beneficiary when you are older.

“So keeping your money in a pension package can be more effective than taking it out of your regular income and donating it,” he says. An inheritance tax expert can help you with this.

Third, not all investment income qualifies for the exemption. Faye Church of asset manager Investec explains: ‘Insurance policies, lump sum cash payments or the capital element of annuities are seen 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.