The seven year rule for inheritance tax
Inheritance tax can make a significant dent in the value of the estate you leave behind. However, understanding the seven year rule in inheritance tax planning can substantially reduce its impact, or even eliminate it altogether.
Are you familiar with the seven year rule and how it affects your long term financial planning?
If not, let’s fill in the gaps.
The seven year rule for inheritance tax is an important factor for those who are likely to be affected by it.
It determines whether ‘gifts’ made during your lifetime are exempt from IHT upon your passing.
In this article, we’ll break down the main topics surrounding this financial planning issue, how it works, and why it’s an essential consideration for wealthy individuals looking to avoid inheritance tax.
What you will learn
- How the seven year rule for inheritance tax works
- The concept of Potentially Exempt Transfers (PETs)
- How taper relief offers the ability to still reduce IHT
- The importance of proper gift documentation
- Strategies to make the most of the seven-year rule
- The benefits of understanding the seven year rule for inheritance tax
Before moving on to our guide to understanding the inheritance tax seven year rule for gifts, let’s cover off what a ‘gift, is in context of this law.
What is a gift?
In the context of the seven year rule, a gift refers to any asset or money you give away during your lifetime.
As an example, this could be a property you own or even a family home. In the UK, putting your house in your children’s name to avoid IHT, is common, however it require thoughtful, careful planning.
On the other hand, certain gifts, like those within your annual allowance or for weddings, may be exempt from inheritance tax altogether.
What is the seven-year rule in inheritance tax?
The seven-year rule refers to the timeframe in which gifts made during your lifetime may still be subject to inheritance tax.
If you survive for seven years after making a gift, it becomes fully exempt from IHT.
For example, gifting property to a family member now means that, after seven years, this amount is no longer included in your taxable estate.
However, if you pass away within this period, the gift may still attract IHT, depending on the timing.
More on this in the next section.
Understanding taper relief
What happens if you don’t make it to the seven-year mark?
Taper relief may reduce the IHT liability on gifts made between three and seven years before your passing.
For example, a gift made five years before your death may qualify for reduced tax rates compared to a gift made within three years.
In summary, the closer the gift is to reaching the seven-year mark, the less tax will be owed.
The importance of documenting lifetime gifts
Proper records are critical to ensure you comply with the rules around claiming exemptions.
For instance, keeping a detailed log of the following will help executors manage your estate effectively.
- Gift amount
- Date
- Recipient
- Reason for the gift
This documentation is really important for proving gifts qualify as Potentially Exempt
Potentially Exempt Transfers (PETs) fall under exemptions such as gifts out of surplus income.
A financial adviser can help you set up a system to manage these records effectively.
How does the seven-year rule work with other exemptions?
Combining the seven-year rule with exemptions like the £3,000 annual allowance or small gift exemptions can boost the tax benefits of your gifting strategy.
In simple terms, it can help you save tax.
For example, you might make a £250 gift to multiple family members annually, ensuring these amounts are immediately exempt from IHT.
On the other hand, larger gifts that exceed these allowances then fall under the seven-year rule. As a result, this offers a tiered approach to reducing your estate’s taxable value.
Ways to use the seven-year rule for inheritance tax effectively
In this instance, strategic lifetime gifting is key. Think through making gifts early and spreading them out over several years. For example, gifting a significant sum of money annually over five years ensures a significant portion of your wealth becomes exempt from IHT over time.
The earlier you start this process the better.
Starting early allows you to make the most of the seven-year rule while providing immediate benefits to your beneficiaries.
Related reading: What does an inheritance tax adviser do?
Quick summary of the seven year rule
The seven-year rule is considered a cornerstone of inheritance tax planning. And, we tend to agree.
By understanding how it works, it can be used as a means to significantly reduce your estate’s taxable value.
Incorporating this rule into a broader financial strategy ensures your wealth is preserved for future generations while minimising the burden on your estate.
Factors to consider
- Start gifting early to fully benefit from the seven-year rule
- Understand how taper relief works
- Get clear on the rules and regulations for documenting gifts
- Seek expert advice to tailor your gifting strategy effectively
- Don’t leave it to chance. You never know what is around the corner
Need advice?
Call us now to request a callback with an experienced inheritance tax adviser.
External resources
- The seven-year rule (GOV.UK)
- The seven year rule for IHT (Money Saving Expert Forum)
- Gifts & exemptions from inheritance tax (Money Helper)