Seven-year rule: Reduce your inheritance tax liabilities!

Many of you will be aware of inheritance tax, even if you are not sure at what level they will be set at, though currently, it is a massive 40%. For many, it is just an accepted fact that when someone dies, the taxman benefits. 

Seven-year rule: Reduce your inheritance tax liabilities!

However, they do not have to benefit to the degree you might think if you are sensible about estate planning to minimize the death duties payable upon your death.

Currently, you are allowed to gift the sum of £3,000 to any member of your immediate family or civil partner before they have to declare that financial gift to Her Majesty’s Revenue & Customs and then pay tax on any amount over £3,000.

Reducing inheritance tax liabilities

On your death, the first £325,000 of your estate is exempt from the 40% inheritance tax levy. However, you can make financial gifts that will reduce the value of your estate when you die. For those who have accumulated a reasonable amount of wealth and who have children, the seven-year rule can be taken full advantage of. Many parents are of the philosophy that their wealth can be of more significant benefit to their children when their children are relatively young, and especially if they also have children. 

How does the seven-year rule work?

If you gift part of your financial estate to either your wife or your children, providing you live for a further seven years, there will be no inheritance tax liabilities apportioned to those financial gifts. However, there is a catch.

If, for example, you decide to gift £200,000 to each of your sons to help them buy their first property, but sadly you die two years later, the beneficiaries of your last will, will receive less than had you not made the financial gifts to your sons. This is because when you make a financial gift, that sum is automatically deducted from the £325,000 portion of your estate which is exempt from inheritance tax. Thus, there would be no portion of your estate that would be exempt from inheritance tax. The portion of your estate, which is exempt from inheritance tax, is usually referred to as the nil rate band.

However, let us look at the £400,000 that had been gifted to your sons. This money is not automatically subject to the full 40% inheritance tax. The nil rate band still applies to the money gifted, hence why it cannot then be applied to the remainder of your estate. Because you died within three years of making the gifts, your sons will have to pay the full 40% on the £75,000 above the nil rate band of £325,00. 

If you die within seven years, the gift will be subject to Inheritance Tax – this is the seven-year rule.

Taper relief for financial gifts

Should you have died five years after you had gifted the money to your sons, the remaining £75,000 would still be subject to inheritance tax, but with a 40% reduction in the amount. This is based on the taper relief that applies to the seven-year rule. If you die within three years, there is no reduction in the tax. If you die between three and four years after the gift was made, the inheritance tax would be reduced by 20% between four and five years that reduction would be 40%, between five and six years, 60% and between six and seven years, 80%. Beyond seven years, there is no tax to pay on the gifts.

The 14-year rule

So, just as you thought you had come to grips with the seven-year rule, now might be a good time to touch on the 14-year rule. This applies in a similar way to the seven-year rule, but it applies to funds left in certain types of trust so that if you die within 14 years of making such gifts, tax on those gifts will be payable.

Key Takeaway

Estate planning is an essential element of preparing your finances for when you are no longer around, but want to make sure that as much of your estate is exempt from inheritance tax. Here at we strongly recommend you make assessments of the following:

  • How much money can you afford to gift to take advantage of the seven-year rule, but not leave yourself in a financially precarious position
  • Assessment of what your current inheritance tax bill would be
  • Whether financial gifts will have tax implications for the recipients
  • Whether leaving money as a gift is more efficient than leaving money in a trust

To find out more about estate planning, the seven and fourteen-year rule, please do get in touch with one of our inheritance tax solicitors and they will be more than happy to advise you of your best options.

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