IHT Paying out excess annual income over expenditure

muddyboots99

For many years (I'm 69) I've  been paying my excess annual income over expenditure to my daughter's to avoid them paying too much IHT. I've never been able to fathom out whether if I draw down tax free cash from my pension pot this can augment my income and therefore increase the payments I can make to my daughter's each year. Or are these tax free receipts treated as capital? There seems to be conflicting views. Thxs

HappyHarry

HMRC have previously indicated that drawings from a pension count as income rather than capital for the purposes of gifting for IHT.

Keep_pedalling

This is one of those horrible grey areas, but I think you will need to draw down the tax free amount over a number of years to establish a pattern of gifting. Giving away £10k a for several years then one gift of £250k followed by going back to £10k a year would typically fail to establish a regular pattern of gifting. Going from £10k to say £35 for the next 10 years would.

Are you keeping good records of your actual expenditure to make life easy for your executors?

DRS1

If you draw the TFLS as part of a regular UFPLS you would probably be OK.  But as @Keep_pedalling says a lump in one year wouldn't be a good idea.

NorthYorkie

Please see IHTM14250 - Lifetime transfers: conditions for normal out of income exemption: out of income - HMRC internal manual - GOV.UK. You will see that 'income' for this purpose does not have to be taxable income. The legislation in s.20 of IHTA merely says income and the Revenue accept that the term has to be determined on 'normal accountancy rules', which is not particularly helpful. I would suggest that there needs to be an element of recurrence or at least an expectation of recurrence. I would also suggest that income need not necessarily be of a constant amount, Therefore, for example, Premium Bond winnings should therefore fall to be treated as income (though if you were to win £1m at one go, that might be a red flag for the Revenue). In addition ISA interest should also be counted.

The question of whether a pension commencement lump sum can be 'income' is, as Keep Pedalling has said, a grey area. Indeed the whole question of whether a particular sum is income or capital is one which has troubled the courts over the decades. Pension Commencement Lump Sums (and similar) are covered by s.637A of ITEPA 2003 which provides that no liability to income tax arises on such sums. If, therefore, it was necessary to grant a specific exemption from income tax, does that not suggest that, without the exemption, the sum would otherwise be income? S.566 of ITEPA brings 'pension income' into charge to income tax except where that is 'exempt income' which is defined as " pension income on which no liability to income tax arises as a result of any provision of Chapters 15A to 18"  and Chapter 15A contains s.637A which specifies Pension Commencement Lump Sums as exempt. 

However, if you are in good health and do not actually need the amount realised by the lump sum, there may be a case for taking the lump sum now and immediately giving it to your daughters. If you do not draw the lump sum it will enter your estate for IHT purposes from April 2027 but if you have gifted the lump sum and live for a further 7 years, it will not. Even if you don't survive, might the lump sum be of more use to your daughters now than at some point in the future? Just a thought.

poseidon1

DRS1 said:

If you draw the TFLS as part of a regular UFPLS you would probably be OK.  But as @Keep_pedalling says a lump in one year wouldn't be a good idea.

Indeed a financial services company (Aberdeen ) have previously established with HMRC that UFPLSs annual withdrawals from a DC pension pot do constitute income for the purposes of the gifts out of surplus income requirements subject to conditions - see below.

https://techzone.aberdeenadviser.com/public/iht-est-plan/gifts-out-of-surplus-income#:~:text=There are obvious benefits to,to apply the gifts must:

Be interesting to learn from the OP the nature of his annual record keeping that would enable his executors to prove gifts out of surplus income ( in the last 7 years before death)  as distinct from £3,000 annual exemptions coupled with potential exempt transfers  ( PETs) for the  remaining payments.

 Specifically what is the record keeping to show these are surpluses over and above normal annual expenditure? People often point to using page 8 of form IHT 403 for this purpose - 

https://assets.publishing.service.gov.uk/media/5f60b44cd3bf7f7234487bf0/IHT403-05-20.pdf

phlebas192

poseidon1 said:

Be interesting to learn from the OP the nature of his annual record keeping that would enable his executors to prove gifts out of surplus income ( in the last 7 years before death)  as distinct from £3,000 annual exemptions coupled with potential exempt transfers  ( PETs) for the  remaining payments.

 Specifically what is the record keeping to show these are surpluses over and above normal annual expenditure? People often point to using page 8 of form IHT 403 for this purpose

Bit of a tangent but this issue does concern me. Unexpectedly, after my father's death, my mother was left with an income much higher than she needs and she's making monthly payments to her children (excluding myself at my request) & grandchildren. These are certainly out of surplus income since her bank balance increases year on year until she decides to gift some of it as a definite lump sum. But she hates financial admin so I've never tried to get her to record the IHT 403 type information. If push comes to shove then I'm pretty sure I could recreate the necessary info for that from from her bank statements but I do wonder if just submitting a record of year start bank balance, amount added to the account from capital, amount removed from the account due to one-off gifts and year end bank balance would show that the other gifts were from surplus income (maybe not every year, but certainly if 2 or 3 years were considered together). I feel that it should but worry about HMRC having a specific form and requiring it to be completed.

poseidon1

phlebas192 said:

poseidon1 said:

Be interesting to learn from the OP the nature of his annual record keeping that would enable his executors to prove gifts out of surplus income ( in the last 7 years before death)  as distinct from £3,000 annual exemptions coupled with potential exempt transfers  ( PETs) for the  remaining payments.

 Specifically what is the record keeping to show these are surpluses over and above normal annual expenditure? People often point to using page 8 of form IHT 403 for this purpose

Bit of a tangent but this issue does concern me. Unexpectedly, after my father's death, my mother was left with an income much higher than she needs and she's making monthly payments to her children (excluding myself at my request) & grandchildren. These are certainly out of surplus income since her bank balance increases year on year until she decides to gift some of it as a definite lump sum. But she hates financial admin so I've never tried to get her to record the IHT 403 type information. If push comes to shove then I'm pretty sure I could recreate the necessary info for that from from her bank statements but I do wonder if just submitting a record of year start bank balance, amount added to the account from capital, amount removed from the account due to one-off gifts and year end bank balance would show that the other gifts were from surplus income (maybe not every year, but certainly if 2 or 3 years were considered together). I feel that it should but worry about HMRC having a specific form and requiring it to be completed.

Correct to worry that there is a specific section on IHT form dealing with this exemption since that is where an executor would need to demonstrate a valid claim for the exemption.

There is also a further issue with your suggested methodology, and that is HMRC's rather arbitrary guidance that in the absence of  evidence to the contrary unspent income after two years is no longer income but has been capitalised.

https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm14250

As Keep_pedalling inferred its a tricky exemption for the average person to utilise,  since purporting to use it without conducting the ancillary administration and record keeping could be problematic for the executors later down the line. Does'nt sound as if your mother appreciates this.

phlebas192

poseidon1 said:

As Keep_pedalling inferred its a tricky exemption for the average person to utilise,  since purporting to use it without conducting the ancillary administration and record keeping could be problematic for the executors later down the line. Does'nt sound as if your mother appreciates this.

That's undoubtedly the case and I don't intend to disabuse her of it. I'm more concerned in helping her live out her life without worries than being bothered if it does end up with a larger IHT bill. She's never shown any interest in wanting to aggressively avoid IHT and at the end of the day, it's her beneficiaries who stand to gain from any IHT claim and her executors (all beneficiaries) should be prepared to put in some effort to justify the claim. 

Fermion

There are various " Gifts from surplus income" template letters available if you search the internet. e.g
https://engine-templates.com/gifts-out-of-surplus-income-letter-template/#example

It's generally best to pay a regular amount as a gift as this demonstrates the regular surplus nature of the income/gifts.

I also go onto online banking every year and produce an annual bank statement showing only the gift payment standing orders and file these online along with a signed copy of the letter.