What is the seven year inheritance tax rule?
Posted on 18th July 2024
Inheritance Tax (IHT) can significantly impact the value of what you leave behind for your loved ones. One way that clients attempt to reduce the value of their estate during their lifetime is to make use of the 7 year Inheritance Tax rules, which can help to gift assets during your lifetime. Our Probate Solicitors in Preston discuss what the 7-year rule is, and how it could benefit you during your lifetime.
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What is the 7-Year Inheritance Tax Rule?
The 7-year inheritance tax rule refers to the principle that gifts made during a person’s lifetime can be exempt from inheritance tax if the person survives for seven years after making the gift. This rule is designed to encourage lifetime giving while ensuring that substantial gifts are still subject to tax if the giver does not survive the seven-year period.
How the Rule Works
When you give a gift, it is classified as a Potentially Exempt Transfer (PET). The key points to understand about the 7-year rule include:
Surviving Seven Years:
If you survive for seven years after making the gift, the gift becomes fully exempt from Inheritance Tax, providing you have not made any other triggering transfers during your lifetime, such as lifetime chargeable transfers.
Death Within Seven Years:
If you die within seven years of making the gift, the gift is taken into account in your estate for inheritance tax calculations. The amount of tax payable depends on the time elapsed since the gift was made, thanks to a process called taper relief.
Taper Relief
The gift will use the nil rate band available on your estate before any other assets are taken into account. Where tax is payable on the gift, taper relief reduces the amount of inheritance tax, when this was made between three and seven years before the date of death. The taper relief rates are as follows:
|
How long before the date of death was the gift made? |
The taper relief inheritance tax rate |
|
0 to 3 years |
40% (no reduction) |
|
3 to 4 years |
32% (8% less) |
|
4 to 5 years |
24% (16% less) |
|
5 to 6 years |
16% (24% less) |
|
6 to 7 years |
8% (32% less) |
|
7 years plus |
0% (40% less) |
Example Calculation
For example, our Probate Solicitors in Preston can give the following example. Say you made a gift of £300,000 and then passed away five years later. The gift would be taxed as follows:
Initial IHT rate: 40%
Taper relief (5-6 years): 16%
Effective IHT rate: 24% (40% - 16%)
Therefore, the IHT payable would be £300,000 x 24% = £72,000.
This example is based, however, on the person making the gift having no nil rate band amount available. You should always seek specific advice from Probate Solicitors in Preston to ensure you understand how taper relief could work in respect of your loved one’s gifts, so that the correct tax calculation and reliefs or exemptions are applied in the correct way. To instruct our Probate Solicitors, call 01772 783 314 or pop into our Preston offices- Garstang or Longridge.
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Types of Gifts and Their Treatment
Not all gifts are treated the same way under the 7-year rule. Here are a few examples:
Exempt Gifts:
Some gifts are immediately exempt from IHT, regardless of when they are given, such as:
Gifts between spouses or civil partners.
Annual exemptions (up to £3,000 per tax year, with the previous years’ unused exemption being able to be carried forward for up to one year, so you could make a gift of £6,000 in the 2024/25 tax year, using your unused annual exemption from 2023/24, for example).
Small gifts (up to £250 per recipient per tax year).
Gifts to charities or political parties.
Wedding or civil partnership gifts within specific limits.
Potentially Exempt Transfers (PETs):
These are the gifts subject to the 7-year rule. If the person who made the gift survives for seven years, the gifts are exempt from IHT.
Lifetime Chargeable Transfers (LCTs):
Some transfers, such as gifts into certain trusts, are immediately chargeable to IHT at 20% if they exceed the available nil-rate band, only attracting the higher inheritance tax rate of 40%, with credit for tax paid, if the person dies within so many years.
Planning Strategies
Understanding and utilising the 7-year rule can be a powerful tool in estate planning. Here are some strategies to consider:
Early Giving:
Start gifting early to maximise the chance of surviving the seven-year period.
Regular Gifts from Income:
Gifts made out of surplus income are exempt from IHT, provided they do not reduce your standard of living.
Use Annual Exemptions:
Take advantage of the annual exemption to gradually reduce the value of your estate.
Life Insurance:
Consider taking out a life insurance policy to cover potential IHT liabilities, ensuring your beneficiaries are not burdened with a significant tax bill.
You should always seek independent financial advice from a qualified professional before making any gifts. Often, our clients at MG Legal will seek advice from a financial planner and our Solicitors in Preston, simultaneously, ensuring that the correct financial and legal advice are received so careful and meticulously planned steps can be taken to mitigate Inheritance Tax.
Important Considerations
While the 7-year rule offers substantial benefits, it’s essential to consider:
Record Keeping:
Keep detailed records of all gifts, including dates and amounts, to simplify the calculation of IHT liabilities.
Professional Advice:
Consult with a financial advisor or estate planner to tailor your gifting strategy to your specific circumstances and ensure compliance with tax laws.
The 7-year inheritance tax rule provides an opportunity to reduce the IHT burden on your estate, ensuring more of your wealth is passed on to your loved ones. By understanding how this rule works and strategically planning your gifts, you can make the most of the available exemptions and reliefs. As always, seeking professional advice can help you navigate the complexities of IHT and develop a comprehensive estate plan that meets your goals and circumstances.
For expert advice, contact our Solicitors in Preston on 01772 783 314 or email enquiries@mglegal.co.uk to find out how we can assist. Our team are experts in estate planning and Probate, so can assist with your estate planning needs, or the estate of your loved one after their passing. Read our excellent reviews, here, to find out why clients continue to choose our team at MG Legal for their legal needs.
Tagged as: Probate, Solicitors in Preston
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