Making financial gifts during your lifetime can be an effective way to reduce a future inheritance tax (IHT) liability. However, misunderstanding how the seven-year gifting rule works could leave families facing an unexpected tax bill.
With inheritance tax thresholds having been frozen for 17 years and set to remain unchanged until at least April 2031, more people are considering gifting assets to family members as part of their estate planning.
Yet one of the most common misconceptions concerns how taper relief applies to gifts made within seven years of death.
Gifts made to individuals during someone's lifetime are generally classed as potentially exempt transfers (PETs). Provided the person making the gift survives for seven years, the gift becomes exempt from inheritance tax.
If they die within that period, the gift may become chargeable to IHT.
Many people assume that once three years have passed, the value of their gift gradually reduces for inheritance tax purposes. However, this is not how taper relief works.
Taper relief reduces the inheritance tax payable on a gift, not the value of the gift itself. Crucially, it only applies where the gift exceeds the available nil rate band, currently £325,000.
Consider someone who makes a gift of £250,000 to a family member and dies six and a half years later.
They might assume that because more than six years have passed, taper relief will reduce the value of that gift by 80%.
In reality, the £250,000 gift falls entirely within their £325,000 nil rate band, meaning there is no inheritance tax payable on the gift itself and therefore no taper relief to apply.
However, the gift uses up £250,000 of their nil rate band, leaving just £75,000 available against their remaining estate.
Depending on the value of the estate and any other available exemptions or reliefs, this could result in a higher inheritance tax liability than the family anticipated.
The distinction is important. While larger gifts exceeding the nil rate band may benefit from taper relief, smaller gifts do not automatically produce a reduced inheritance tax liability simply because several years have passed.
Although inheritance tax still affects a relatively small proportion of estates, the number of deaths resulting in an IHT liability increased by 3.6% between 2022/23 and 2023/24, according to HMRC.
With property values and other assets having increased while tax thresholds remain frozen, more families could find themselves exposed to inheritance tax.
Lifetime gifting can still be a valuable planning tool, but the timing, value and nature of gifts all influence the eventual tax position.
Gifting assets during your lifetime can help reduce inheritance tax, but relying on the seven year rule without understanding how the nil rate band and taper relief interact can lead to costly assumptions.
There are also other exemptions worth considering, including the annual gifting exemption and gifts made from surplus income, which may offer opportunities to reduce the value of an estate without relying on the seven year rule.
The important point is that effective inheritance tax planning is about more than simply giving assets away and waiting seven years. Reviewing the wider estate, making appropriate use of available exemptions and keeping accurate records of gifts can all make a significant difference.
If you are considering making gifts to family members or would like to review your inheritance tax position, please get in touch with our tax specialists at Forrester Boyd.
Further information and inheritance tax statistics can be found here and more information on HMRC’s guidance on inheritance tax and gifts can be found here.
All data and figures referred to in our news section are correct at the date of publishing and should not be relied upon as still current.
