Estate planning often seems like a daunting task. Although nobody likes to think about what could happen down the line, making financially sound decisions earlier on in life can help you leave a greater legacy behind for loved ones.
If you have large financial assets that you would like to give, you can reduce the burden of Inheritance Tax by making gifts earlier on in life. If you’re wondering what is the 7 year rule in Inheritance Tax and how you can use it to your advantage, keep reading, we’ll explain everything.
What is Inheritance Tax?
Also known as IHT for short, Inheritance Tax is a charge issued on assets, like property, possessions, or money, that have either been inherited or received as a gift.
Typically, this one-off tax bill is charged at a rate of 40%. However, if you donate 10% of your estate to charity, your IHT liability is reduced by 4% to 36%.
If the amount gifted does not surpass the nil-rate band of £325,000 per individual, your financial gift will not be subjected to Inheritance Tax. Couples who are married or in civil partnerships can pass on their tax-free allowance to their spouse or civil partner, bringing the total limit per couple to £650,000.
In addition to this, there is now a Residential Nil Rate Band (RNRB) enabling property to be passed down to children or other direct descendants. This threshold increases every year in line with inflation rates based on the Consumer Price Index (CPI). From 2017-18 onwards, there is an additional transferable main RNRB of £100,000, which is set to increase by £25,000 each year until 2020-21. After this, the threshold is raised in accordance with the CPI. This will eventually bring the total IHT allowance for couples to £1 million. Moreover, the nil-rate band, which was frozen since 2009 will increase in line with CPI in the 2021-2022 tax year.
What is the 7 year rule in Inheritance Tax?
So, what is the 7 year rule in Inheritance Tax? As the name suggests, this rule in Inheritance Tax comes into play after you make a financial gift to someone and live for the subsequent 7 years.
If you pass away before the 7 year mark, the gift will fall under your nil-rate band, where it could be subjected to tax if it surpasses your tax-free allowance.
Regardless of your gift’s value, the beneficiary becomes exempt from Inheritance Tax if the benefactor lives past the 7 year threshold.
Under these circumstances, your gift becomes a Partially Exempt Gift or Potentially Exempt Transfer (PET). However, in order to comply with the 7 year rule in Inheritance Tax, the gift must be issued from an individual rather than an established Trust or business.
Who does it apply to?
The 7 year rule in Inheritance Tax applies to any gifts received whose value surpasses the annual gifting allowance.
Each year you can give away up to £3,000 in gifts without having to pay Inheritance Tax. If you haven’t used up your allowance from the previous year, it can roll over once to a maximum of £6,000. However, there are other exceptions to this rule, such as wedding gifts from parents and grandparents, which fall outside of taxation even if the benefactor dies before the 7-year mark.
Gifts that surpass the allowance and nil-rate band of your estate, could be subjected to IHT or, adversely, the 7 year rule.
What is taper relief?
Taper relief is a sliding scale of percentage reduction that can be applied when the benefactor dies before the 7 year mark.
If the donor survives for 3 years or more after giving the gift, the amount of tax relief will be adjusted appropriately.
As long as it is affordable, it could be wiser to give gifts earlier than later, as you could reduce the amount of Inheritance Tax substantially or even eliminate it completely.
Is there a 14 year rule?
So, we’ve explored what is the 7 year rule in Inheritance Tax in the UK, but what about the 14 year rule?
Yes, once multiple gifts within trusts come into play, these rules become a tad more complicated. If you add a gift into a Trust, you create instant Inheritance Tax bills and these series of gifts can accumulate over the years.
In this instance, gifts made up to 14 years before your death may be subjected to Inheritance Tax, therefore it’s worth speaking to a professional advisor before you start to add these to your Trust.
Final thoughts
Individuals of all ages should take estate planning seriously and start planning their future. In fact, the earlier you start, the better.
With a greater understanding of the 7 year rule In Inheritance Tax and estate planning as a whole, you can reduce potential risks and maximise financial opportunities.
If you’ve read through this article and you’re still asking yourself what the 7 year rule in Inheritance Tax is, at Efficient Portfolio, we work with a wealth of professionals who will be able to advise you further on the topic. Contact us today.
