How the taxman helps you to help your family in these difficult times
In my last couple of blog posts, I have looked at how you can give financial assistance to your children and grandchildren if they are finding things tough as a result of coronavirus.
In this post, I’ll be looking at how the taxman can help out too.
2020 – the year of the regular gift from surplus income
OK, it’s not a catchy name, and I think we are probably more likely to remember 2020 for other reasons. But this could be the year when this inheritance tax exemption gets the attention it deserves.
Our clients are telling us that they are spending less this year, and, as a result, many are likely to have more surplus income than they have had previously.
It is probably the least used of all of the inheritance tax exemptions, and it works like this:
-The gift must be made from “surplus income”. You have to have more income than expenditure, to be able to make use of this exemption. The definition of income is interesting as the income doesn’t have to be taxable, and it doesn’t have even to be received by you.
So, if you have an ISA, and the investments in the ISA pay dividends or interest, that income counts, even if you reinvest it. If you make a profit from renting a property but put the rent aside to cover future maintenance, that still counts.
If you want to use the exemption, HMRC will want to know what your annual expenditure is, but they don’t need too much detail (less detail than you would include in your financial plan!). Your expenditure is deducted from income to work out if you have a surplus.
-The gift must be regular. Importantly, this doesn’t mean that it needs to be the same amount every year. There must be an intention to make a gift every year, and it’s a good idea to keep a record of this. But the amount you give away can go down and up.
In the current year, many of us won’t be spending as much as usual on holidays, entertainment or car expenses, so this is a year when the amount you can give might be higher. Next year, if things are back to normal, you could give away a lesser amount.
If the gift is regular and made from surplus income, it is immediately exempt from inheritance tax.
So, you could make a significant gift from your surplus income, to help your son or daughter, and it could be free from inheritance tax. That means that the taxman will, effectively, be contributing 40% of the gift, as he won’t be collecting inheritance tax on this money in the future.
This can be particularly useful as a way of covering regular payments which your son or daughter cannot afford to miss, like council tax or life insurance premiums.
Give the Gift of Financial Planning
In my previous post, I explained how a plan for the future should follow a short term bailout. That will entail a review of your financial plan (or the creation of one, if you don’t have one), and the review or creation of a financial plan for the child who needs support. Financial plans are not simple to create, and if they are not put together by a professional, they will likely include a fatal flaw.
But the taxman can help you to pay for the financial plans.
Each person can make a gift of up to £3,000 in each tax year, free from inheritance tax; if you didn’t make a gift in the year to 6th April 2020, you could give away £6,000. So, a married couple who didn’t take advantage of the annual exemption last year can give away £12,000 in total, without any inheritance tax consequences.
You don’t have to make a direct gift of the money – you can pay for something for the recipient instead, and the payment will count as the gift. It’s always worth documenting that you have made a gift, and particularly so when you have made a gift in this way.
So, if you pay to have a financial plan drawn up for your son and daughter, this gift should be free from inheritance tax – think of it as the taxman reducing the cost of the financial plan by 40%.
Picking up Pension Contributions
Pension contributions are often seen as being less essential than many other items of expenditure. In extreme circumstances, this is right – nobody should be making pension contributions when they can’t pay the gas bill!
But pension contributions remain an important item of expenditure, and it’s best to carry on paying them if you can. If you stop paying into your pension now, you will have to accept a lower standard of living in retirement, or retire later; the only alternative will be to increase the amount you pay into your pension when things get back to normal.
The scheme member and their employer usually pay pension contributions, but third parties can make pension contributions too. Some people have taken advantage of this rule to pay into pensions for their grandchildren, but you can pay money into a pension for anybody else – you don’t even have to be related to them.
So, if your son or daughter is struggling financially, you can pay their pension contributions for them. If they have a personal pension or SIPP, you will pay contributions net of basic rate tax (so if you want to add £1,000 to their pension, it will only cost £800). When you contribute, you have made a gift to them, and this could be a regular gift from surplus income or part of the annual exemption. The amount of the gift is the amount you pay (£800 in the example above). You can pay contributions as a lump sum or monthly.
The combination of income tax relief and the potential inheritance tax savings means that the taxman provides a considerable boost, with the net cost of the pension contribution, if you take account of the income tax relief and inheritance tax saving, being less than 50% of the amount which is added to the pension.
If you would like to talk more about how you can help your children in these difficult times, please get in touch.