I make £6M and want to give £1M a year to my adult children, can we cut the inheritance tax risks?

I started a modest software company 27 years ago and it has become fairly successful. My wife and I have benefitted accordingly and our combined earnings and annual dividends amount to £6 to 8million. 

I hasten to add that we pay all of our UK taxes as UK residents – despite the fact that as a Canadian, our accountants have suggested we should explore the ‘non-dom’ options.

As you would expect we have substantial cash savings, investments and are debt-free. We live well – but don’t live extravagant lives and the bulk of our earnings end up simply topping up our investment pot for the future.

We have also set up a trust, with our five children as beneficiaries, which has £2million invested.

I will be 66 soon and my wife 57. I expect to retire some time in the next two to three years. A sale of the business is likely at that time – garnering a further large capital influx as things stand. 

Over the past six years or so my wife and I have helped the eldest four of our five children with some fairly substantial deposits and gifts to assist in buying their own homes or paying down their mortgages and debts. Each of them has received approximately £300,000 during that time.

Our fifth child (who is 20, the oldest being 40) will benefit similarly at an appropriate time in his life. 

We have tried to do so in a manner which ensures their need to work and lead useful lives is not compromised and they must make their own way in life.

The children know we have money – but have no idea whatsoever of the full extent of our wealth. 

What I don’t want to do is fall foul of His Majesty’s Revenue and Customs when it comes to the gifting rules and cause the children problems should we die before the seven-year rule makes them ‘safe’ of any such issues. 

So my question is – for so long as I am still working – is it reasonable to gift up to £1million of the £6million+ we earn annually to the children without causing issues with HMRC and the gifting rules. 

Obviously we both hope to outlive the seven years required to escape the tax ‘net’, but who can see into the future? J.V

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Harvey Dorset, of This is Money, replies: Having built a company that has turned into a great success, you would understandably like to pass some of the money you have made from this to your family. 

Ideally, you want to do this without shelling out 40 per cent in the form of inheritance tax, which seems reasonable considering the amount of tax you will have already contributed in the UK over your working life.

Given your level of wealth, the existing standard annual gifting allowances of £3,000 per year in total maximum, with exemptions of multiple gifts of up to £250 limited to one per receipient, and a special £5,000 for weddings, won’t get you very far.

You are welcome to give away more than this but the ‘seven-year rule’ means gifts made during your lifetime are only fully exempt from IHT if you survive for seven years after making them. 

Luckily, there is another way that you can pass money on, provided you take certain measures to ensure you follow the rules and keep detailed records.

Gifting out of surplus income allows you to make regular and consistent gifts out of income you can prove is surplus to your living requirements. Officially, this is known as ‘normal expenditure out of income’.

This is Money spoke to two financial advisers to find out the best way for you to pass on your wealth to your family, and explain more about gifting out of surplus income.

Claudia Button, financial planner at Quilter, replies: When gifting money to your children, it’s important to be aware how the inheritance tax rules work to avoid any unexpected tax liabilities. 

The key rule to keep in mind is that gifts you make during your lifetime are generally only fully exempt from IHT if you survive for seven years after making them. 

If you were to pass away within that period, those gifts could still be counted as part of your estate and potentially subject to IHT. 

The good news is that the tax liability reduces over time, so the longer you live after making a gift, the less tax your children would potentially have to pay.

If a gift is made within three years of passing, though, it could attract the full 40 per cent IHT charge.

That said, there are ways to give money without triggering IHT. You and your wife each have an annual gifting allowance of £3,000, which can be carried forward for one year if unused. This means you could give up to £6,000 tax-free in a single year. 

However, the larger gifts you’ve given your children, such as the £300,000 each, would likely fall outside this exemption and need to be considered under the seven-year rule.

To safeguard against potential IHT liabilities on the larger gifts you’ve made, consider taking out a life insurance policy written in trust. This can provide a payout to cover any IHT due if you pass away within seven years of making the gifts, ensuring your children aren’t left with an unexpected tax bill.

A particularly useful option for you, given your high income, is making gifts out of surplus income. HMRC allows individuals to give money regularly from their income, provided it doesn’t affect their standard of living. 

If your earnings far exceed your spending, then gifting £1million a year from income could be a legitimate way to pass on wealth without any IHT concerns, so long as you document this properly and ensure it’s genuinely coming from income rather than capital.

Since you’ve already set up a trust for your children, it’s worth keeping an eye on how that fits into your overall financial planning. 

Trusts can be a great way to pass on wealth while maintaining an element of control, ensuring that money is used wisely. 

However, depending on how the trust is structured, it may itself be subject to periodic IHT charges, so it’s worth reviewing this with your adviser to make sure it remains tax-efficient.

Looking ahead to the sale of your business, careful planning will be essential to ensure the proceeds are handled in the most tax-efficient way. 

You may be eligible for business property relief, which could reduce the IHT liability on business assets if certain conditions are met. 

You might also want to explore options like a family investment company or other trust structures to help manage the wealth from the sale.

In short, given your financial position, gifting £1million a year from your income could be a viable strategy, provided it’s structured correctly. 

However, as with any major financial decision, it’s worth getting tailored advice to make sure your plans align with both your estate planning goals and HMRC’s rules. 

It may also be a good time to review your trust arrangements to ensure they’re working as effectively as possible as you move toward retirement.

What counts as surplus income? 

Peter Hargreaves, financial planner at EQ Investors, replies: Making gifts throughout your lifetime is an effective way to ensure that you leave as much as possible to your loved ones while also helping to mitigate your exposure to inheritance tax. 

There are several options available when it comes to gifting money, each with its own considerations.

A tax-efficient method, particularly while you are earning a high income, is making gifts out of surplus income. These gifts are IHT-free from the moment they are made and are not subject to the seven-year rule. 

Even in retirement, you can continue using this exemption, though your available surplus income may be lower due to reduced earnings.

Surplus income refers to any income remaining after covering all necessary expenses and outgoings. It is important to remember that income is not limited to employment or pension earnings but also includes interest, dividends, and rental income.

There is no monetary cap on gifts made from surplus income, meaning the amount you give is only limited by how much surplus income you generate. To qualify for the exemption, these gifts must:

• Form part of a regular expenditure pattern (i.e, be consistent and ongoing)

• Be made out of income rather than capital

• Leave you with sufficient income to maintain your usual standard of living

These gifts can be made directly to beneficiaries or to a trust and will not be subject to the seven-year rule.

Keep a file of your all payments and your income history – this will be helpful evidence that your executors or giftees can present to HMRC should they question your inheritance tax liabilities when you pass away. 

It is also recommended that before your first payment, you write a letter of intent to the recipient of your financial gifts, outlining that they are being made out of surplus income, as this is another reference that can be given to HMRC on your death.

You could also make ad-hoc gifts directly to beneficiaries or to trusts and these will be subject to the seven-year rule. 

As you have gifted more than your £325,000 nil rate bands, if you pass away within seven years of making the gift, the inheritance tax will be collected from the people who received the gift, rather than from the estate. 

The previous gifts you made outright and into trust should be considered when making further gifts.

To mitigate this risk, you might consider a gift inter vivos plan. Gift inter vivos insurance is a form of term (life) insurance that covers the potential IHT liability. 

That is created when someone gives a sum of money or other assets away while alive and they die within seven years of giving the gift. The policy will last seven years – if the tax is liable for the gift.

Given your level of wealth, you may also want to consider family investment companies. These are vehicles which have become widely used as an alternative to trusts for investment and succession planning purposes in recent years. 

FICs may be suitable for succession planning purposes, as shares in the company could be given to children or grandchildren who, depending on the rights of the shares, may be able to receive distributions from the company. 

This may be especially relevant where an individual wishes to provide for their grandchildren (for example, to assist with payment of school fees).