“If my family will face Inheritance Tax on things I leave them when I die, what’s to stop me from giving them my assets now?” Clearly you haven’t heard of the 7 Year Rule.
Inheritance Tax in a Nutshell
Before diving into the world of Inheritance Tax (IHT) planning and the 7 Year Rule, it’s important to understand what IHT is and who might end up paying it.
IHT is the tax owed on your estate after you die, based on the total value of your property, investments, savings, and any other assets less any debts (such as your mortgage). Currently, pensions are not included as part of your estate, but this is set to change in 2027 according to Chancellor Rachel Reeves’ Autumn Budget in 2024.
The current threshold is £325,000 for each individual, with an additional allowance called the Main Residence Nil-Rate Band or RNRB of £175,000 for homes under £2 million in value. Any assets over the £325,000 allowance (or £500,000 allowance if the RNRB is included) will then be taxed at a hefty 40%.
There are certain requirements to qualify for the RNRB; it must be for your main property and does not cover any other properties such as holiday homes or rentals, and the allowance is reduced by £1 for every £2 over the property value threshold of £2 million. I.e. if your property was valued at £1,100,000, you would be £100,000 over the threshold and have your allowance reduced by £50,000.
Both allowances may be brought forward for your spouse or civil partner when you die, meaning a married couple could potentially have a total IHT allowance of up to £1 million, provided that they meet all the qualifying criteria.
What is the 7 Year Rule for Inheritance Tax?
Your family will be expected to pay any IHT due within 6 months after your death, meanwhile they won’t have access to the assets that you’ve left them – which resulted in the tax bill – until probate is completed up to 2 years later.
This leaves many families worried and searching for solutions that will mitigate this tax. An obvious solution to IHT is to gift assets to your family whilst you are alive, but this comes with its own set of rules and risks that you should be aware of.
Taxable gifts are either Chargeable Lifetime Transfers (CLT), which are subject to a 20% IHT charge, or Potentially Exempt Transfers (PET), which is where the 7 Year Rule comes in.
From the date that you make your gift, or PET, you have started a clock which will run out in 7 years. If you were to die within 7 years of making the gift, the person who received it will still be charged IHT, but this might be reduced.
As previously mentioned, any assets over the threshold are taxed at 40%, but the IHT due on gifted assets will taper off over the course of the next 7 years, as follows:
- 40% for the first 3 years
- 32% for 3 to 4 years
- 24% for 4 to 5 years
- 16% for 5 to 6 years
- 8% for 6 to 7 years
- 0% after 7 years
This means that if you gifted your child £50,000, but died 4 years later, your child you be taxed at 24% on the gift, totalling £12,000.
As with the IHT allowances, there are exceptions to this rule, and certain assets are automatically exempt from IHT regardless of when death occurs. For more information on this, you should speak to a professionally qualified adviser or tax planner to help you before making any decisions.
The Problem with Gifting
Currently, only around 4% of deaths result in an IHT charge (according to data collected by the government in 2020-21). This might not sound like a lot, but based on the current UK population, that’s approximately 2.78 million people paying Inheritance Tax, and that number is predicted to increase to 12% of the population by 2032-33.
A key factor in this number rising is escalating house prices. Individuals or couples who own their home and have seen the value of their property steadily increase over the past few decades may be at risk of exceeding the IHT allowance, even if their ‘liquid assets’ are quite low. This effectively disqualifies some people from being able to make use of the 7 Year Rule through gifting, as they don’t have anything to give that would lower the value of their estate.
Of course, gifting before death is not your only course of action, and there are several options available to you in order to protect your family from paying high tax charges.
If you would like to start planning more for the long term and consider what will be left to your family – hopefully a healthy inheritance, not a healthy tax bill – then please get in touch. I can walk you through your options and provide you with advice regarding gifting, the use of trusts and other forms of asset protection.
Whatever you decide to do, please make sure that you make decisions with all the information to hand, and speak to a qualified professional first.
Ian Brammer (MSWW) is a full member of The Society of Will Writers. He is regulated, insured and fully trained.
