What is 'income' for making regular gifts forming part of normal expenditure / inheritance tax?

My_perfect_cousin

Thanks in anticipation of your help.
What can be included as 'income' for making regular gifts (whilst retaining sufficient income to maintain a normal standard of living after allowing for all other gifts forming part of normal expenditure)?
I presume that monthly work and state pension, dividends from shares are allowable as income.
I'm less sure about whether 'income' from interest gained from bank / building society savings can be included.
I presume that travelling expenses from unpaid, voluntary work would not be allowable as 'income'. 
I'd value any advice please. thanks

Malthusian

The definition of income for the purpose of this relief in the HMRC tax manual is deliberately vague: "Income is not defined in the Inheritance Tax Act 1984 but should be determined for each year in accordance with normal accountancy rules." These cases are all however clear-cut.

"Monthly work and state pension, dividends from shares" - these are all income, including shares within ISAs.
"Interest gained from bank / building society savings" - this is also income, again including cash ISAs.
"I presume that travelling expenses from unpaid, voluntary work would not be allowable as 'income'." Well, your travelling expenses have already been spent on, er, travelling, so you don't have the money to give away.

Unless you're fiddling your expenses, but I wouldn't go declaring that to HMRC as your estate would stand to lose more than 40%.

When your heirs complete the IHT forms (and you should be keeping records yourself to help them), your expenses can be included in your income if your travelling expenses are included in your expenditure. Either include both or leave out both. The form asks for annual income and travelling expenses would usually be variable in nature, so excluding your charity expenses from your personal expenditure figures would seem easiest.

Sea_Shell

The rules do seem stacked against those who choose to only draw as income just what they need, even if their funds could support larger withdrawals!   But then if one upped their "income" to excessive amounts, they would probably pay more tax😉.

But pay 20% to potentially save 40%?

I take it's very individual too, or does it take into account household excess income?

Keep_pedalling

Sea_Shell said:

The rules do seem stacked against those who choose to only draw as income just what they need, even if their funds could support larger withdrawals!   But then if one upped their "income" to excessive amounts, they would probably pay more tax😉.

But pay 20% to potentially save 40%?

I take it's very individual too, or does it take into account household excess income?

I am not sure I understand what you are saying here. If I have income of £40k pa and expenditure of £25k then I can give away £15k from excess income, If I have a more lavish lifestyle and have £40k+ expenditure I can’t make gifts from excess income. But in both cases I am paying the same amount of income tax and not adding to my estate’s potential IHT liability.

Sea_Shell

Keep_pedalling said:

Sea_Shell said:

The rules do seem stacked against those who choose to only draw as income just what they need, even if their funds could support larger withdrawals!   But then if one upped their "income" to excessive amounts, they would probably pay more tax😉.

But pay 20% to potentially save 40%?

I take it's very individual too, or does it take into account household excess income?

I am not sure I understand what you are saying here. If I have income of £40k pa and expenditure of £25k then I can give away £15k from excess income, If I have a more lavish lifestyle and have £40k+ expenditure I can’t make gifts from excess income. But in both cases I am paying the same amount of income tax and not adding to my estate’s potential IHT liability.

I mean taking larger pension drawdown than you need and paying income tax, rather than taking just your personal allowance of £12,570 and then topping up (and gifting) from your capital (ISA or cash savings)

When the pension could support , say £25k drawdown, with normal expenditure of £20k, so £5k of income is "excess".

But you'd pay tax that way.  


Unless SIPPs aren't counted as income in this (IHT) respect?

My_perfect_cousin

thanks all. If I was to receive a tax free cash lump sum from a LGPS work pension on retirement my presumption is that cash lump sum would not be considered as income for the financial year in which I would received it? And as such couldn't be included in my calculation of income for that year. Is my presumption correct? many thanks again

Malthusian

Sea_Shell said:

I mean taking larger pension drawdown than you need and paying income tax, rather than taking just your personal allowance of £12,570 and then topping up (and gifting) from your capital (ISA or cash savings)

Why would you do that when pensions are outside the estate and can be passed on to the giftee free of IHT anyway?

The only way it could make sense is if your intended beneficiary will be in a higher tax bracket than you - and usually that would mean it would make more sense to direct the pension fund elsewhere.

My_perfect_cousin said:

thanks all. If I was to receive a tax free cash lump sum from a LGPS work pension on retirement my presumption is that cash lump sum would not be considered as income for the financial year in which I would received it? And as such couldn't be included in my calculation of income for that year. Is my presumption correct? many thanks again

It is not income, and you can only give away a pension commencement lump sum once because you only get it once, so it isn't going to be a regular gift either. 

Sea_Shell

Malthusian said:

Sea_Shell said:

I mean taking larger pension drawdown than you need and paying income tax, rather than taking just your personal allowance of £12,570 and then topping up (and gifting) from your capital (ISA or cash savings)

Why would you do that when pensions are outside the estate and can be passed on to the giftee free of IHT anyway?

The only way it could make sense is if your intended beneficiary will be in a higher tax bracket than you - and usually that would mean it would make more sense to direct the pension fund elsewhere.

My_perfect_cousin said:

thanks all. If I was to receive a tax free cash lump sum from a LGPS work pension on retirement my presumption is that cash lump sum would not be considered as income for the financial year in which I would received it? And as such couldn't be included in my calculation of income for that year. Is my presumption correct? many thanks again

It is not income, and you can only give away a pension commencement lump sum once because you only get it once, so it isn't going to be a regular gift either. 

It's all a bit chicken and egg really.    We could leave our pensions untouched and live off other investments or savings so that money stays free of IHT, but then we would lose the tax free element of drawdown up to our PA.

Our beneficiaries (after each other) are not our children, and I have no idea what tax bracket they may be in when we pass.   I doubt they would be, but you never know, they may do really well for themselves.

It was just a thought question in reality, as I can't see that we will want to be gifting in excess of £3000 each BEFORE we start receiving other pensions, which will take us over our PA and count as relevant income.  

I'm sure they'll still be very happy to share an inheritance of over £650,000 !!!   Even if it means a big IHT bill.  


Now we're off to try and not both get run over by a bus!!! 

Malthusian

Sea_Shell said:

It's all a bit chicken and egg really.    We could leave our pensions untouched and live off other investments or savings so that money stays free of IHT, but then we would lose the tax free element of drawdown up to our PA.

My question was purely about "taking larger pension drawdown than you need and paying income tax, rather than taking just your personal allowance of £12,570".

If you can take taxable income out of the pension without paying income tax on it, it usually makes sense to do so; and if you don't need the money and it's likely to accumulate in the estate, then the "regular gifts out of income" rule might avoid the risk of incurring 40% IHT in an attempt to avoid income tax on pension withdrawals. If it qualifies as a regular gift (which it might not if it's a short term tax planning exercise).

People in this situation are usually pre State Pension age (as the State Pension tends to swallow up most of the personal allowance once it's in payment) and would therefore have a good chance of surviving seven years anyway.