How do I navigate the “7-year rule” for inheritance tax?

How do I navigate the “7-year rule” for inheritance tax?

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Wealth Solutions in our Edgbaston or Warwick offices.

Is it true that you can escape inheritance tax (IHT) if you give something away – such as property to your children – and survive the gift by 7 years? In this guide, our financial planners in Edgbaston and Warwick explain how the “7-year rule” works, some ideas for integrating it into an estate plan and common pitfalls to watch out for. We hope this is helpful to you. If you’d like to speak to one of our professional financial advisers then you can reach us via:

T: Edgbaston 0121 446 5815
T: Warwick 01926 888091
E: [email protected]

What is the 7-year rule for inheritance tax?

In 2022-23, the UK levies inheritance tax (IHT) typically at 40% on the value of an individual’s estate over £325,000. Given that this could result in thousands lost to the taxman after death – rather than the money going to your loved ones – it is little wonder people are attracted to the 7-year rule. The overall idea is fairly straightforward, but over half of Britons do not understand it due to the intricacies involved in the details.

For example, let’s assume you make a gift of £50,000 to a child while you are still alive. If you live more than 7 years afterwards, then the gift would not be counted as part of your estate for Inheritance tax purposes. However, this rule is complicated by the following facets of the law:

  1. The annual exemption. This allows you to give away up to £3,000 per tax year – either to one person or to many – without this getting counted in your estate for IHT calculations. So, in the above example involving £50,000, it may potentially only be £47,000 that is at stake under the 7-year rule. You can also carry this allowance forward by up to one tax year, giving a total exemption of £6,000 if you have not made any gifts in the previous year.
  2. The “taper relief”. If your total gifts in the previous seven year period exceed the nil rate band (£325,000), taper relief may apply. Once you have survived your gift by 3 years, a taper starts to apply on the normal 40% tax that would apply to your gift. In years 3-4, for instance, the rate goes to 32%. At 4-5 years it will be 24%; then 16% at 5-6 years; 8% at 6-7 years and then finally 0% once 7 years have passed.

The 7-year rule and estate planning

The 7-year rule might seem like an easy way to sidestep IHT. However, relying on it can create difficulties for your executors if you die within 7 years of making your gift. For instance, suppose you give away a classic car to a relative, worth £150,000. This makes it a Potentially Exempt Transfer (PET) since the gift exceeds £3,000 and is not made into a trust. Suppose you die a year later and the total value of your estate is over the £325,000 IHT-free threshold. This means that the value of the car will be added back into the estate, using up £150,000 of the available nil rate band, potentially increasing the IHT liability by £60,000.

One option to mitigate this would be to take out a seven year term assurance policy for £60,000. This means that if you die within seven years of making the gift, the insurance policy will pay out a sufficient sum to pay the tax. To avoid increasing the value of your estate further, the insurance policy should be placed in trust.

Another way to approach the 7-year rule is to place a gift (over £3,000) in a discretionary trust. This classifies it as a Chargeable Lifetime Transfer (CLT). There is no limit to CLT gifts. However, you will need to pay a “lifetime tax” of 20% on any excess over your Nil Rate Band (£325,000). However, this is available as a credit against recalculated IHT liability if you die within 7 years of the gift.

Other tools to consider

This is barely scratching the surface of the 7-year rule, and you may already be thinking how complex it is (you are correct!). Fortunately, you do not have to rely on it when planning for IHT. There are many IHT exemptions available for gifts which you may benefit from after discussing with your financial adviser. In addition to your £3,000 annual exemption, these include:

  • Gifts to a spouse/civil partner. Assuming this person is UK domiciled, then any gifts to them are IHT-free. Wedding gifts. You can give up to £5,000 to a child, £2,500 to a grandchild / great grandchild and £1,000 to anyone else.
  • Gifts from income. If you can demonstrate that a gift does not reduce your standard of living, then you can make IHT-exempt gifts from income.
  • Family maintenance gifts. You can make gifts to a dependant to help with living costs without needing to pay IHT.
  • Charitable gifts. No IHT is due on gifts to registered charities. If you give at least 10% of your estate to charity upon death, then your IHT rate goes down to 36%.
  • Giving to political parties. Assuming the party has at least 2 MPs in Parliament and one of them achieved 150,000 votes in a general election, you can make IHT-free gifts to it.

Invitation

We hope this content has been informative and inspired you to develop your own financial plan. Please get in touch if you’d like to discuss these matters with us via a free, no-commitment consultation with a member of our team:

T: Edgbaston 0121 446 5815
T: Warwick 01926 888091
E: [email protected]

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