Countless families grappling with substantial Inheritance Tax obligations following seven year rule misunderstanding.
Thousands of families have been shocked to face huge tax bills on lifetime gifts, resulting from the donor dying within seven years of making them.
The ‘seven year rule’ is often referred to when donors look to make gifts free from inheritance tax (IHT). The catch is, in order for these gifts to be free of IHT, the donor must survive seven years from the date of making the gift, hence their name “potentially exempt transfers” (PETs).
If you do not survive the seven year period, then the situation is more complex. Each of us have a current nil-rate band (NRB) of £325,000. This means that when you die, the first £325,000 of your estate is IHT free. If you make a PET which is equal to or below £325,000 then you do not need to worry about IHT. However, anything above this NRB will be subject to IHT, at the normal rate of 40 per cent. There is a tapering system which provides a discount on this normal rate depending on when it is you died within the seven years (see below).
For instance, if you die within 3 to 4 years of making the gift, the total IHT payable will be 32 per cent rather than the normal rate of 40 per cent. It is important to note that this is not applied directly to the value of the gift, rather, it is applied to the residue which is over £325,000. For instance, you make a gift of £400,000 and then die within the next 3-4 years. It is the remaining £75,000 that will be taxed, so in this scenario a total 32 per cent is taxable meaning £24,000 in IHT would be due. You can see how this can add up quickly and take away from a gift that you wanted to be fully enjoyed.
| Period between the date of gift and the death of the donor | Total IHT payable including the discount |
| 0-3 years | 40%- No discount |
| 3-4 years | 32% |
| 4-5 years | 24% |
| 5-6 years | 16% |
| 6-7 years | 8% |
| 7+ years | 0% |
None of us can know when we will die, it could be in 50 years or it could be tomorrow, but it is safe to say that most of us do not want the gifts we make to be taxed. This goes to show how important it is to start your estate planning early and do not get caught out by the seven year rule.
There are many straightforward steps we can take during our lifetime to reduce IHT and we would be delighted to discuss these with you. This article is for general information only and does not constitute legal advice. If you would like to discuss anything in this article, please get in touch with Nikki Perryman, a solicitor in our Wealth Management team on 01483 567676 or nperryman@cheyneygoulding.co.uk
