If you’re considering making a financial gift, it’s important to be aware of the seven-year rule in Inheritance Tax. 

Inheritance Tax is charged on the value of assets that have been transferred from one person to another via inheritance or as a gift. Most people know it is paid when someone dies but not everyone is aware that it can also apply to some gifts made before death.

HMRC has put in place a set of rules to prevent people from avoiding an Inheritance Tax bill by simply giving away all of their money on their deathbed.

If you’re making a financial gift, you need to understand whether the gift is tax-free, or whether it will create a tax bill, either immediately or further down the line. 

Understanding the seven-year gift rule in Inheritance Tax 

Some gifts are exempt from Inheritance Tax (as I explain below). Everything else is defined as either a chargeable lifetime transfer (CLT) or a potentially exempt transfer (PET).

A CLT applies to gifts put into a discretionary trust that may be subject to an immediate IHT charge. A potentially exempt transfer (PET) is where the gift will only be completely tax-free if you live for seven years after gifting it. If you die within seven years of gifting the asset, then the gift will count towards the value of your estate so it may still be liable to IHT. After seven years, the gift doesn’t count towards the overall value of your estate. This is called the seven year gift rule in Inheritance Tax. 

The rules can get even more complicated if you make a series of gifts or gifts into certain types of trusts. Some gifts into trusts create immediate Inheritance Tax bills and, if you have made a series of gifts over time, gifts up to 14 years prior to your death may affect how much tax is payable on those gifts.

What is taper relief? 

A key aspect of the seven-year rule in Inheritance Tax is taper relief. This applies if the donor dies before the seventh anniversary of making the gift. It has the effect that, as long as the donor lives for at least three years after the gift, the Inheritance Tax payable on the gift is calculated at a percentage rate. This reduces for each year the donor lives towards the crucial seven-year anniversary. 

Inheritance Tax exempt gifts 

If you die within seven years of gifting an asset to an individual, the seven-year gift rule means that the beneficiary may be required to pay IHT. However, some types of gifts made during your lifetime won’t incur IHT. These include gifts:

  • To your partner or spouse. Any gifts you make to your UK-domiciled spouse/civil partner are free from Inheritance Tax, and some gifts to non-UK domiciled spouse are also exempt.
  • For a wedding or civil partnership. You can gift up to £5,000 to a child, £2,500 to a grandchild/great grandchild, or £1,000 to anyone else to fund a wedding or civil partnership. 
  • From your excess income. As long as the gift doesn’t affect your usual standard of living, you can make gifts out of your normal income.
  • To charities. You can make gifts of any value to charities without paying Inheritance Tax. 
  • Gifts to political parties. Finally, gifts you make to political parties are exempt from Inheritance Tax. (But do check the small print on this one).

There is also an annual exemption for Inheritance Tax-free gifts worth up to £3,000. This means that every year you can gift up to £3,000 free from Inheritance Tax. Furthermore, you can carry over an unused annual exemption from the previous year. And finally, there’s the small gifts exemption. This enables you to make an unlimited number of small Inheritance Tax-free gifts each year, outside of your annual exemption. These gifts are for up to £250 each, provided you have not already used another exemption for the same person. 

It is vital to be aware of the seven-year rule in Inheritance Tax if you are thinking of making a significant financial gift. As I have explained, this is more complex than it might first appear so speak to your professional advisor before making a decision about gifting your assets. 

Contact your usual Thomas Westcott advisor for help with this and any other estate planning needs.

By Ann Jackson, Partner