View more on these topics

What is the normal expenditure out of income exemption?

More clients need to know about the rule and the tips for staying within it

The normal expenditure out of income exemption is greatly underused, but can be a valuable way for parents and grandparents to gift excess income to their beneficiaries free of any inheritance tax concerns.

Research we have conducted found a staggering 90 per cent of people with excess income and an inheritance tax concern might consider using the exemption in order to pass wealth on in a tax-efficient way.

With increased knowledge of this exemption and the right solutions in place, it should be possible for more clients to do so, either on death or during their lifetime.

Passing on wealth during lifetime
Parents and grandparents are increasingly wanting to pass on wealth during their lifetime to help their children and grandchildren, but the potential IHT concerns may be restricting them.

The current IHT annual gifting allowance is set at just £3,000 a year (and has not increased since 1981), so there is a real risk that gifts over and above this limit could be subject to IHT if the donor dies within seven years. At 40 per cent, this is a valid concern.

The normal expenditure out of income exemption opens up more options, particularly for those who still work, or who have some excess income they do not need but want to save for their beneficiaries.

It will also help clients in later life who do not spend all the income they receive and want to pass the excess on without being concerned about the seven-year IHT rule.

income exemptionUsing the exemption to build a tax-efficient trust fund
The exemption becomes extremely powerful when the excess income is paid into a trust and can accumulate over time. This is especially useful when saving for minors, for example. A client may want to accumulate money for their beneficiaries to use in the future, perhaps to pay for university costs or as a house deposit.

Using trusts to save tax efficiently for the benefit of minors is a well-known concept. Provided the payments to the trust come from excess income and meet set criteria, they will not be subject to the usual chargeable lifetime transfer charge for discretionary trusts.

Online calculators can help advisers check with their clients whether the payments would meet HM Revenue & Customs’ definition of being from excess income.

Tips for ensuring payments stay within the normal expenditure out of income exemption rule:

  • Payments must be from income – this includes earned income, dividends, interest, rental income or pension income. It does not include capital.
  • Payments must be from normal expenditure – HMRC adopts the dictionary definition for “normal” which means: regular, typical, habitual or usual.
  • Keep a consistent pattern – HMRC will look for a pattern over a reasonable period of time, generally considered as three to four years – but payments do not need to be the same amount on the same date or over a set period.
  • Based on current income levels – payments should be from current income. Accumulated income from previous years may be deemed as capital and therefore ineligible.
  • No negative impact – there must be no negative impact on the donor’s standard of living after making the payment.
  • Keep clear records – it is very important that documents and evidence of intention to make regular payments out of normal expenditure are kept and can be used by personal representatives as evidence to claim the exemption.

If our research is anything to go by, there could be widespread appeal from your clients in the normal expenditure out of income exemption. Using the exemption to fund payments into a trust solution is powerful. Trusts are already tax efficient, but the removal of the chargeable lifetime transfer charge on contributions from income will make it even more straightforward for people to pass on their wealth, either during their lifetime or on death.

Rachael Griffin is financial planning expert at Old Mutual Wealth

Recommended

Pension-Pensioner-Depressed-Elderly-Man-500x320.jpg

£150m in pensioner benefits left unclaimed

Close to a million British pensioners who qualify for the Government’s Cold Weather Payments and Warm Home Discounts scheme have missed the boat as winter ends, Royal London has found. Royal London director of policy Steve Webb says lack of communication between pensioners and their families is leading to the increasing number of elderly who […]

File image of Three piggy banks tucked in a drawer
1

Compensation bill hits asset managers after FCA closet tracker review

The FCA has revealed that asset managers have paid back £34m to investors overcharged by so-called “closet tracker” funds. While the regulator has not ordered the move as part of any official redress scheme, The Sunday Telegraph reports that the FCA is eyeing enforcement action against one fund manager over potentially misleading marketing material. FCA […]

Gregg McClymont 480
1

Gregg McClymont: Why I need a financial adviser

Combining risk frameworks with appropriate asset allocation is no mean feat Economists call them “teachable moments”. A life event which make us think more about long-term financial planning. Until my 40th birthday, I barely thought of my mortality. But since then I have barely thought of anything else. A major birthday milestone combined with the arrival […]

Investment

View from the CEO

Andrew Carter, CEO of Royal London Asset Management, offers his latest view of the market. View the article here The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s […]

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

    Leave a comment