This is the kind of tax-planning problem we would all like to have. Given that winning or, more likely, accumulating one million pounds is not so rare these days, what steps should you take to keep as much of it as possible out of the hands of HMRC?
Keep the paperwork
If you have just come by a large sum of money unexpectedly, the paperwork might not be the first thing on your mind. Of course, if you are lucky enough to be one of the only two premium bond holders per month who win a million pounds, your win will be well-documented. Success in the National Lottery should equally be independently verifiable. In the unlikely event that it came from betting or gaming, you need to keep third-party evidence to be in a position to defend yourself against accusations of tax fraud or even money-laundering.
Is it taxable?
Lottery wins and premium bond prizes are not taxable. Winnings from betting are also free of tax. If your windfall is a legacy from a deceased person’s estate, the executors should have sorted out the tax before distributing the funds. So, you only need to be concerned if your million pounds has somehow come to you by virtue of your trade, profession or work; because in these circumstances it would probably be subject to income tax.
Spend, spend, spend.
In my experience, the population is divided evenly into spenders and savers. If you are a spender, we can assume that the million pounds will find its way back into the economy relatively quickly, yielding many opportunities for the taxman to take a share. For example, if you buy a brand-new Lamborghini expect it to set you back about £210,000. HMRC will collect £35,000 in VAT and the DVLA will get £2,000 in vehicle excise duty. Supposing you use all of the money to buy a house, stamp duty land tax, payable by you, will amount to £43,750.
The rainy day fund
Some will decide to put the money aside for old age or unforeseen emergencies. Opportunities to shelter it from tax are limited though. The most you can invest in an ISA in any one year is £20,000, and if you are considering pension contributions, you can only pay the equivalent of your annual earnings up to a maximum of £40,000. (You should always seek professional advice before paying into a pension fund).
The philanthropist
You may be moved or persuaded to share your good fortune with others. Gifts to registered charities fall outside the scope of Inheritance Tax and where they are made out of taxable income by Gift Aid, their value is enhanced from the recipient’s point of view, plus the donor gets higher rate tax relief.
If for you charity begins at home, you will no doubt consider making gifts to family members. Such generosity will consequently reduce the value of your assets and therefore reduce the Inheritance Tax (IHT) liability on your estate when you die. There is currently no IHT liability on lifetime gifts but if you die within 7 years of making a gift it will be added to your estate for IHT purposes. The percentage of the gift added to your estate reduces gradually over the 7 years.
There are some gifts that are not added to your estate. Any gift of £250 or less is ignored. Every year you can make gifts totaling £3,000 that are not added to your estate, and if you don’t use the £3,000 in one year then you can carry it forward to the next. As gifts between spouses are exempt, you can pass money to your spouse who can then use his or her £3,000 exemption as well.
Other gifts which are exempt from IHT are:
- wedding gifts of up to £1,000 per person (£2,500 for a grandchild or great-grandchild, £5,000 for a child)
- gifts out of your income, such as Christmas or birthday presents
- payments to assist with an elderly relative or dependent child’s living expenses
- gifts to charities and political parties
You can’t take it with you
Let’s assume that you don’t spend or give away the money you have won so that it remains part of your estate when you die. The first £325,000 of your net assets is not taxed (nil rate band), and if your spouse has died before you without using his or her nil rate band, that can also be claimed, meaning that the first £650,000 is tax-free. The nil rate band can be increased by a further £125,000 per spouse if you leave your family home to your children or grandchildren and if the value of your estate is less than £2 million.
Your share in the family business will in most cases not count towards the value of your estate.
Having claimed the above reliefs, the balance of your estate is taxed at 40%. Of course, at that point, it will be your children’s problem, not yours. However, there are steps you can take during your lifetime to maximise the amount you pass on to your children. Even if you haven’t just won a million pounds, it would be a good idea to ask us to review your affairs and advise you on planning for the inevitable.
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