Gifting property to the children
No one likes the idea of the taxman taking a chunk of their estate when they die, particularly if it will be necessary to sell a much-loved property to pay the inheritance (IHT) bill. The introduction of the residence nil rate band (RNRB -set at £175,000) means that a couple can now leave combined estates worth £1 million free of inheritance tax where this includes a residence valued at £350,000 or more, which is left to direct descendants. However, the RNRB is reduced where a person’s estate is worth more than £2 million and lost where the value of the estate exceeds £2.35 million.
If it looks likely that there may be IHT to pay, the idea of taking steps to reduce this is attractive. Where property is given away more than seven years before the donor’s death, it escapes IHT. Giving property to the children may, at first sight, be an attractive option, but there are traps to be aware of.
Giving away the main residence
If the main residence is given away, there will be no capital gains tax to pay as long as the main residence exemption applies in full. However, if the property is retained by the children as an investment property, the capital gains tax clock will start to run from the date that they acquire it. By contrast, if the property is gifted at death, there will be a capital gains tax uplift to the value at death, but there may be some inheritance tax to pay (potentially at 40%).
Problems can arise if the parents give the property to the children but continue to live in it. There are two sets of anti-avoidance rules that can apply – the gifts with reservation rules (GWR) and the pre-owned asset (POA) rules.
The GWR rules apply where a donor gives an asset away but continues to derive benefit from it. An example would be parents who transferred their home to their children but continued to live in it. The rules effectively ignore the transfer for inheritance tax purposes, such that it forms part of the death estate.
The POA impose an income tax charge on the previous owner if they give a property away but continue to live in it, based on a notional market rent of the property.
Seeking to take an investment property outside of the death estate can trigger a capital gains tax charge where a property is given to a child, even if no money changes hands. The child is a connected person and the property is deemed to be disposed at market value. This may trigger a capital gains tax bill of 18% or 28% of the gain (to the extent it exceeds the annual exemption), which must be paid within 30 days (but with no proceeds from which to pay the tax).
Giving away property in an attempt to save inheritance tax can be very complicated and it is easy to get it wrong; professional advice should be taken in advance.
Pension annual allowance – Making tax relieved contributions
Tax relief is available to encourage individuals to make contributions to registered private pension plans. However, while there is no limit to the amount that an individual can contribute to their pension plans, there are limits on the contributions that qualify for tax relief. One of those limits is the annual allowance.
Tax relieved contributions for a tax year cannot exceed the higher of 100% of earnings or £3,600, and must be covered by the available annual allowance.
Nature of the annual allowance
The annual allowance limits the amount that an individual can make in tax-relieved pension contributions across all their registered pension schemes. The basic annual allowance is set at £40,000 for 2021/22. However, an individual’s annual allowance may be less than this if they are a high earner or if they have already flexibly accessed their pension.
If an individual has not used up their annual allowance in the previous three years, they may be able to make tax relieved contributions of more than £40,000 in 2021/22. However, where earnings are less than the available annual allowance, tax-relieved contributions are capped at earnings (or £3,600 where this is amount is more than earnings).
Only one annual allowance is available regardless of the number of registered private pensions that an individual has. The annual allowance applies to total contributions made to a defined contribution scheme in the tax year and any increase in the value of a defined benefit scheme in the tax year. Pension contributions made by an employer to a private pension scheme count towards the annual allowance.
The amount of the annual allowance is reduced where, for the tax year in question, a person has both adjusted net income of more than £240,000 and threshold income of more than £200,000. Broadly, adjusted net income is income including pension contributions and threshold income is income excluding pension contributions.
Where both tests are met, the annual allowance is reduced by £1 for every £2 by which adjusted net income exceeds £240,000 until the minimum amount of the annual allowance is reached. For 2021/22, this is set at £4,000. No reduction is made to the annual allowance if the threshold income is £200,000 or less, regardless of the level of adjusted net income.
Consequently, anyone with adjusted net income of £312,000 and threshold income of more than £200,000 will have an annual allowance of £4,000 for 2021/22.
Money purchase annual allowance
A lower annual allowance, the money purchase annual allowance (MPAA), also applies if a person has flexibly accessed their pension on reaching age 55 or above. This is to prevent recycling of contributions to secure further tax relief.
For 2021/22, the MPAA is set at £4,000.
Unused annual allowances
If a person has not used their annual allowance in full for a year, the unused amount can be carried forward for up to three years. However, unused allowance for earlier years can only be used once the allowance for the current year has been used in full. Unused allowances from an earlier year are used before those of a later year.
Contributions in excess of the annual allowance
If tax-relieved contributions are made in a tax year in excess of the available annual allowance for that year, a tax charge applies to claw back the tax relief to which the individual was not entitled.