Families exploit lesser-known exemption to dodge Rachel Reeves's inheritance tax increase
Reducing Inheritance Tax Through 'Gifts Out of Surplus Income': A Strategic Approach
In the wake of Chancellor Rachel Reeves's recent tax reforms, a little-known strategy for avoiding inheritance tax (IHT) – 'gifts out of surplus income' – remains a highly effective and underutilised method. Despite changes impacting pensions, business reliefs, and the worldwide assets of non-domiciled individuals, this relief has not been targeted or restricted.
This relief allows individuals to make regular, tax-free gifts from income that exceed their usual expenditure, effectively reducing the estate subject to IHT without using the standard £3,000 or other gift allowances. By demonstrating that gifts are made out of surplus income rather than capital, individuals can make unlimited gifts, making it one of the most effective mechanisms for reducing inheritance tax liability available today.
However, the use of this relief requires careful documentation and a clear demonstration of surplus income status. As a result, it may be underused due to administrative burdens or misunderstanding. For families who plan and maintain proper records, it remains a highly valuable tax planning tool.
Under Rachel Reeves's new reforms, families will face a double tax charge of income tax (if the deceased was over 75) and death duty on inherited pensions. Top rate taxpayers who inherit pension pots where the deceased was aged over 75 face paying death taxes of almost 70 per cent. This change, set to take effect from April 2027, will likely drive more families to explore strategies like 'gifts out of surplus income' to mitigate their inheritance tax liabilities.
The Government expects to rake in more than £3.4 billion from pension pots in the form of inheritance taxes by 2030. Currently, private and workplace pension funds do not form part of an estate upon death and have not been liable for inheritance tax. This change will significantly impact the number of families affected by IHT, particularly those with substantial pension pots.
The niche rule allowing taxpayers to give away unlimited funds without inheritance tax if the gifts do not diminish their quality of life and are derived from income, not savings, is likely to be increasingly utilised as families seek to minimise their IHT liabilities. It's worth noting that this rule does not apply to public sector defined benefit pensions.
Despite these changes, nine in ten estates will continue to pay no inheritance tax by 2030, according to a HM Treasury spokesperson. The number of families using this little-known loophole to avoid IHT has nearly tripled, with the amount of money transferred under this loophole increasing from £52 million in 2022-23 to £144 million in 2023-2024.
The Office for Budget Responsibility expects savers to shield more than £2.2 billion from the new death tax on pensions by 2030. As the reforms take effect, it's expected that more families will turn to strategies like 'gifts out of surplus income' to minimise their IHT liabilities and preserve their wealth for future generations.
In summary, while Rachel Reeves's tax reforms will impact many areas of the inheritance tax system, 'gifts out of surplus income' remains a strategic and effective method for reducing IHT. However, careful documentation and planning are crucial to ensure that gifts qualify for this relief.
- Investing in 'gifts out of surplus income' could be a strategic approach to avoid inheritance tax (IHT), especially with Chancellor Rachel Reeves's new tax reforms impacting pensions, business reliefs, and worldwide assets of non-domiciled individuals.
- By demonstrating that gifts are made out of surplus income rather than capital, individuals can make unlimited tax-free gifts, making it a valuable tool for personal-finance and estate planning.
- In the future, more families might consider using 'gifts out of surplus income' to mitigate their inheritance tax liabilities due to changes like the double tax charge on inherited pensions.
- As the reforms on retirement savings take effect, finite resources may lead families to explore finance strategies like 'gifts out of surplus income' to preserve their wealth and reduce inheritance tax liabilities.
