The Difference Between Chargeable Lifetime Transfers (CLT) and Potentially Exempt Transfers (PETs)

A Sunday Times article by Ali Hussain entitled “Inheritance Tax is Staying but here’s how to avoid it” discussed various useful ways in which to reduce a potential inheritance tax bill. The easiest way to reduce your Estate is to spend it!  This can be done either by enjoying the money yourself during your lifetime or gifting it to friends, relatives or charities. It is also important to make the distinction between Chargeable Lifetime Transfers and Potentially Exempt Transfers (Lifetime Gifts).

What is a Chargeable Lifetime Transfer (CLT)

A Chargeable Lifetime Transfer (CLT) is immediately chargeable to IHT (Inheritance Tax). Such transfers commonly involve payments into a Trust which will incur a 20% payment to IHT on anything over the settlor’s Nil Rate Band (NRB).

What is a Potentially Exempt Transfer (PET)

A Potentially Exempt Transfer (PET), also known as a Lifetime Gift, is a gift that is not immediately chargeable to IHT but reduces the donor’s amount of available NRB (currently £325,000) by the amount of the gift (less the available annual allowance). Once 7 years has passed and assuming the donor has not expired during this time, the NRB clock is reset and the gift exempt from IHT altogether. If the donor died within 7 years, then the gift may still be exempt from IHT if the value was within the NRB (i.e. under £325,000). If the gift exceeded the value of the NRB, or there were numerous gifts and the aggregated value exceeded the NRB, then tax will be payable at 40% on the proportion of the gift over the NRB, with the most recent gift being the first in the firing line. Depending on when it was made the 40% may be subject to taper relief of between 20% to 80% if it was made more than 3 years before the date of death.

Gifts to charities and spouses are exempt from IHT and therefore you can gift as much as you like during your lifetime to either or and there will be no IHT payable.

Each person has a total annual gift allowance of £3,000 which means that an individual can gift up to that sum without it affecting their NRB.

Gifts of up to £250 will not count towards this total unless they are made to the same person, in which case they are aggregated and the total amount of money gifted to that particular person in one year will apply over £250.

Any unused annual gift allowance can be rolled over into the following tax year for one year only.  This means if you only use £1,500 of your gift allowance in one tax year, you can roll over £1,500 to the next giving you a maximum of £4,500 in the next tax year.  If you only gift £500 in that tax year, you can still only roll over a maximum of £3,000 to the next year.  This can be useful if you are a couple and want to gift a large amount to a child or grandchild.  If both of you have unused allowance from the previous year, it means that potentially a couple can make a single gift of up to £12,000 to one person in a single tax year without it affecting their NRB.

The rules also allow individuals to make wedding gifts to children of £5,000 without it affecting the NRB.  If it’s grandchildren, it’s £2,500 and for anyone else, £1,000.  Again, a couple could potentially make a gift of £10,000 in this respect.

The article also points out that surplus income is an underused way of giving away money without any tax implications.  You can give away as much surplus income as you like without IHT consequences as long as it does not diminish your standard of living and the payments are habitual.  Therefore, you could make a regular payment of £300 out of your income to someone on a regular basis and it would not decrease the NRB.

To learn more about how PETs and CLTs affect you, get in touch with Annelise Tyler by email annelise.tyler@wellerslawgroup.com or by phone 01732 446374 today.