WETs, PETs and CLTs: Part 2

In the previous post we looked at wholly exempt transfers (WETs), and how these small transfers can help reduce any IHT liability insofar that they are totally exempt from any IHT being levied.

For larger gifts (which would naturally have a larger IHT reduction), the rules are a little more complex. We have all heard of Potentially Exempt Transfers (PETs), but why are they so effective, and how exactly do they work?

A PET is an outright gift to an individual or bare/absolute trust, which would normally be subject to IHT. However, the IHT payable is put on hold for a period of 7 years. If the giftor passes away within 7 years, then IHT would be payable. If the donor survives for 7 years, then no IHT would be payable and the gift would be fully outside of one's estate for IHT purposes.

Before we explore the mechanics, it must be said that the gift has to be outright. Any retained benefit in the gift (even if not used), would make the gift one with reservation and the 7 year count down would not commence until all retained benefits have been foregone. This is best by using some examples.

A wealthy couple leave their seaside cottage to their daughter. They continue to use the cottage for occasional holidays without paying the market rent for using the property. This is clearly a gift with reservation. If they commence to pay the market rate for renting the property, then their reservation has been removed and the 7 years will start counting only from that time and not from the actual date of the gift.

Another example, which is less obvious, would be gifting an asset/capital to a bare trust (this is a PET). However, if the settlor (or even their spouse/civil partner) COULD benefit from the trust, they will be deemed to have a retained benefit in the gift. Even if the settlor never did have any benefit, the mere fact that they are able to, is sufficient to deem this a gift with reservation. In this instance, it would be strongly advised to exclude the setllor and their spouse/civil partner, from any benefit from the trust. This would clearly indicate the absolute nature of the gift.

If the giftor survives for 7 years after the gift, then no IHT would be payable. When death occurs within 7 years of the gift, IHT would be payable at a rate of 40% on the value of the gift (the value is at the time of the gift, not the time of death).

If death occurs between 3 and 7 years after the gift, then the IHT payable would be reduced by taper relief. With a 20% incremental reduction per year from year 3 onwards, the payable amount of IHT can be reduced. For example, if a gift was made with the value of £100,000 and death occurred between 5-6 years after the date of the gift, the IHT payable (£40,000) would be reduced by 60%, meaning that only 40% of the £40,000 would be payable (£16,000).

What is very important to note, is that it is the recipient of the gift who is liable for the IHT payable on a failed PET. Whilst it is not required to notify the HMRC at the time of the gift, it is good practice to ensure that the recipient is aware at the time of the gift, that they may be liable for a tax charge in the event the donor passes away within 7 years.

There are strategies available to eliminate/reduce the risk of this payable levy falling squarely on the shoulders of the recipient.

PETs are a VERY effective way of passing on wealth to future generations, however, they should be done with careful planning and are not always the best option for all people.

Chargeable lifetime transfers (CLT), may be better suited for certain individuals. Interested to know what a CLT is, and how it can reduce any IHT? Check out next weeks post where we discuss this in a bit more detail.