What Is Gift Inter Vivos?
When planning for gifts inter vivos, consider the tax implications and the benefits of including international tax planning in your strategy.
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Introduction
A gift inter vivos, which translates as “gift between the living,” is a legal term used to describe a transfer or gift made during the grantor’s lifetime.
Since inter vivos gifts do not form part of the donor’s estate upon death, they are exempt from probate taxes. This includes gifts of estate-related property. Inter vivos transfers are those that are made while the grantor is still alive.
If you give money to someone other than your spouse or a qualified charity, you may be required to pay gift taxes if you give more than $16,000 annually (as of 2022).
At the time of the transfer, the gifted property’s actual value is determined. The recipient of the gift does not have to report it to the IRS or pay income taxes on it, but if the amount exceeds $16,000, the giver of the gift is required to do so.
Before gift taxes are actually levied, there is a lifetime exclusion for the donor, which is annually adjusted for inflation. By 2022, a person will be able to give away $12.06 million without having to pay gift taxes.
What is Gift Inter Vivos?
Several factors make a gift inter vivos a practical estate planning tool. Giving to a charitable foundation allows the donor to claim the value of the gift as a tax credit on their tax return, which has the added benefit of avoiding probate taxes.
Furthermore, unlike gifts that are left by way of a will or a trust, many people give inter vivos gifts merely because they want to manage the gift while they are still alive.
It is appealing to many people to have the freedom to distribute the property as intended. A grantor’s assets and business affairs can continue to be somewhat private because there are only very light reporting requirements.
Gift Inter Vivos and Inheritance Tax Liability
A gift inter vivos policy is an insurance policy used in the financial world to cover inheritance tax obligations that may arise when someone makes a gift to another person while they are still alive and, in the absence of any other exemptions, may be subject to inheritance tax for the following seven years.
Every individual has access to the nil rate band, which is a personal inheritance tax exemption. It currently stands at £325,000, though some individuals may have a higher allowance depending on their circumstances.
This is the portion of their estate that is completely free of any inheritance tax liability. The current inheritance tax rate is 40% and applies to assets that are passed on above the nil rate band.
The good news is that in addition to the nil rate band, there are specific rules pertaining to these lifetime gifts that help to limit or reduce the liability.
If the recipient lives for a minimum of 7 years after the gift is made, the recipient is immune from inheritance tax on gifts made from the estate of the deceased.
These donations are unlimited in value and are referred to as theoretically exempt transfers (also known as PETs). If someone passes away during these 7 years, inheritance tax may still be due, albeit it may become less likely as time goes on.
Taper relief is the term used to describe this decrease in liability. If a person makes a donation and dies within three to seven years, they are subject to a full 40% tax liability, although gifts made earlier are subject to a sliding scale.
Creating life insurance plans to cover the lowering obligation is the most popular method of shielding the recipients of these gifts from the prospective tax liability. These policies are referred to as “gift inter vivos.”
These policies have a fixed 7-year term, with cover decreasing gradually when taper relief takes effect to match the decreased liability. Even when the coverage is lessened, the premium often stays the same for the full 7 years.
However, it’s crucial to determine whether taper relief will truly apply before establishing a gift inter vivos strategy. When someone gives a lifetime gift, it is initially deducted from their nil rate band.
As a result, the first consequence of any gift—or successive gifts—is to effectively lower their nil rate band for the seven-year term, increasing the liability on the remaining estate during this time.
Additionally, taper reduction is applied to the tax rate rather than the gift’s value. As a result, the taper relief has no impact on gifts that fall inside the nil rate zone because the tax rate is zero.
How to Make a Gift Inter Vivos
When making a gift, the donor must have the ability to do so and be at least 18 years old.
A gift and irrevocable transfer of ownership or title is required, as well as written confirmation of the gift’s intention. A donor cannot intend for the gift to be given to someone else after his passing.
Particularly if the gift entails the transfer of property or something that is practically hard to transport, delivery should be immediate, either physically or symbolically.
After making a gift, the giver renounces all ownership of the item and is unable to claim it back without the recipient’s consent.
The tax-exempt nature of the gift may be voidated if any effort is made to manage the gifted property or gain an advantage from it. This would call into question the transfer’s legality and make it taxable.
The gift must be accepted by the receiver as well. The law deems the recipient to accept the gift if it has true value. To avoid any misunderstandings and to legally seal the deal, it is usual for the recipient of the gift to confirm their acceptance in writing.
Example of Gift Inter Vivos
Julia wants to give her family home to her grandson Mike. Mike recently got married and is expecting a child, and Julia wants to go to her second house in Florida to escape the harsh winters.
In good health and having recently retired, Julia is aware that Mike could utilize the property—or the proceeds from its sale—immediately to support his expanding family.
To explain further, let’s say someone chooses to give a present that is worth £450,000. They utilised the £3,000 annual exemption for gifts and haven’t given anything else during the past seven years.
The taper reduction will only apply to the rate of tax payable on this amount, not the entire gift, as the value of the gift exceeds their zero rate band by £125,000. Moreover, an appropriate solution for the tax burden on this sum is a gift between vivos policy.
Therefore, in this case, a policy that starts with £50,000 of coverage and then decreases by £10,000 every year after year three would be advised.
But there is another factor to take into account that many people forget about.
You should think about what obligations there are on the remaining assets in the person’s estate in addition to setting up the gift inter vivos policy.
The beneficiaries of the remaining estate have a greater obligation because the nil rate band has been used up, which will last for seven years or until the gift is no longer considered part of the estate and the full nil rate band becomes available once more.
As taper relief does not apply to this amount, they should think about paying this liability through a level term guarantee, unless the rest of their estate would be exempt from inheritance tax, such as because it is all being left to a spouse or civil partner.
The necessary insurance is worth £130,000, or 40% of the tax due on the nil rate bracket. It is also necessary to specify the policy period for this at seven years.
Similar to this, it is important to take into account the obligation that is still there when gifts are provided that are below the nil rate band.
For instance, if someone chooses to give a present for £250,000 and, as previously, they haven’t given anything else during the previous seven years, their donation will be considered a lifetime gift. This gift’s value is within their nil rate band, thus taper relief will not be used.
A gift inter vivos policy is not a workable solution in this situation. Instead, they should think about taking out a 7-year level term insurance policy for £100,000 to cover the increased liability on their remaining estate.
This amount is equal to the 40% tax due on the portion of the nil rate band that has been used.
What happens if the total amount of your cumulative gifts exceeds the nil rate band?
Assume someone gave a gift worth £240,000 512 years ago and has since decided to give another gift worth £240,000. Thus, they have received a total of £480,000 in gifts and have crossed the zero rate band by £155,000. So you would believe that a £62,000 inter vivos donation would be appropriate.
Unfortunately, people frequently err in this way.
The first gift, which was made seven years ago and is no longer included in the inheritance tax calculation, was made in 112 years. The taper relief would never be able to apply to the later gift because the remaining gift of £240,000 will then be less than the nil rate band.
Therefore, a gift inter vivos policy is not an appropriate solution for the tax liability on this sum. In this case, a level term insurance policy for £96,000 with a term of 7 years would be suitable because it would cover the 40% tax obligation.
However, if the initial gift had been made to a discretionary trust rather than a prospective exempt recipient and so was a charged lifetime transfer, the narrative would have been very different.
The tax due on the second donation would still be determined by taking into account the previous gift, even though there would be no additional tax to pay in those circumstances.
This is due to the fact that you must additionally consider if there were any prior chargeable transfers within the seven years prior to the gift in order to ascertain whether any tax is due on the second donation.
In this situation, the value of the first gift plus the previous chargeable lifetime transfer exceed the nil rate band, and the excess is therefore chargeable if the donor passes away within seven years of the second gift.
A gift inter vivos policy would be appropriate because there would also be taper relief available.
So far, gift inter vivos policies and when to use them and when to avoid them were discussed, but are there other choices?
Apart from the infrequent occasions when a gift inter vivos policy will be sufficient, they also have the drawback of being scarcely available from companies.
As a result, they are occasionally less economical than they may be. There is an option, albeit it is not quite as straightforward and is still very worthwhile to examine.
Multi-cover Plan
Someone might think about creating a multi-cover plan out of a group of five level term assurance covers as an alternative to the gift inter vivos policy.
These five covers each have a term of three, four, five, six, or seven years. One fifth of the obligation should be the amount for each cover.
For instance, setting each of the five covers at £20,000 if you had gifts that exceed the zero rate band by £250,000 and a 40% inheritance tax liability of £100,000 as a result.
For the first three years, this will provide full coverage of £100,000 (5 x £20,000) before the first policy expires. After that, as the subsequent multi-plan policy completes its full term, the total coverage offered will decrease by £20,000 annually.
Thus, you will still have 4 covers, providing £80,000 in coverage, at the end of year 3. There are three policies left that will pay £60,000 at the end of year four, and so forth.
Or, if the situation is even more complicated and the gifts were given in different years, the cover can be adjusted to cover the liability as the older gifts are subtracted from the calculation.
Since there are virtually no limitations, this is a much more adaptable and economical solution than conventional gift inter vivos policies.
Creating a Trust for the Plan
Whatever alternative for insurance is chosen, it is strongly advised that it be put into trust.
By doing this, the benefits of a claim on the insurance policy will be prevented from being included in the estate of the person who made the claim, which would increase the liabilities and somewhat defeat the objective.
Additionally, it prevents the policy from being subject to probate, allowing for speedy payment to the beneficiaries and prompt payment of the liabilities.
Typically, there is no additional cost to establish the trust using the life insurance provider’s own forms. Given that they are the ones responsible for paying the tax, the gift recipient should benefit from the gift inter vivos policy.
In order to ensure that the funds are available for the liability on the estate to be paid, this policy should be for the beneficiaries of the residual estate if the liability on the estate is being covered.
In conclusion, calculating the liability on lifetime gifts can be challenging, and there are plenty of pitfalls for the unwary. However, doing it correctly and making sure your client is covered can really benefit from it.
Check out our articles on Best Investing Options for American Expats and Best Investing Options for Australian Expats.
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Adam is an internationally recognised author on financial matters, with over 760.2 million answer views on Quora.com, a widely sold book on Amazon, and a contributor on Forbes.
