Inheritance Tax (IHT) is paid on an estate before assets are passed to beneficiaries. It’s usually due within six months of death, though there can be exceptions. IHT adds up over time, considering past gifts when working out how much tax is owed, although there may be exceptions. While IHT is typically paid upon death, it may also apply to certain gifts given during a person’s lifetime. If you’re giving a financial gift, you should check whether it’s tax-free or if it could lead to a tax bill now or later. That’s why understanding the 7-year rule is important.

When you pass away, the first £325,000 of your estate is tax-free (£650,000 for married couples or civil partners who leave everything to each other on the first death). If you leave your home to direct descendants (like children or grandchildren), you get an extra tax-free allowance of £175,000 per person (£350,000 for married couples or civil partners). Anything above these limits could be taxed at 40%, unless you qualify for certain reliefs.

HMRC defines a gift as anything of value, such as money, property, or possessions, that is given away. It can also include a reduction in value when transferring an asset—for example, if you sell a property to your children for less than its market value, the difference between the sale price and the actual value is considered a gift.

The 7-year rule

The 7-year rule determines if you pay IHT on certain types of gifts. Some gifts are exempt, while others fall into two categories:

· Chargeable Lifetime Transfers (CLTs) – Gifts to discretionary trusts that may incur an immediate 20% IHT charge (if paid by a Trust) or 25% (if paid by the giver).

· Potentially Exempt Transfers (PETs) – Gifts to individuals of unlimited value which become exempt from IHT if the giver survives 7 years. Note: gifts to businesses or trusts do not qualify as PETs.

If the giver passes away within 7 years, the gift counts towards the nil-rate band, and may still be subject to inheritance tax. Once 7 years have passed, the gift is no longer included in the estate’s total value. This is the 7-year rule. However, a failed CLT may cause a previous PET to be reintroduced into the estate for assessment due to the 14-year rule, which I will not cover in detail here.

To protect your wealth for loved ones, certain gifts are exempt from inheritance tax if given during your lifetime. Here are some examples:

· Gifts to your spouse/partner – Tax-free if your spouse/civil partner is UK-domiciled, with some exemptions for non-UK domiciled spouses.

· Gifts from income – Regular gifts (e.g., birthday presents, life insurance premiums) that don’t affect your standard of living.

· Wedding gifts – depending on the amount gifted and the relation of the person making the gift.

· Charitable gifts – such as donations to charities, museums, sports clubs and universities are exempt.

· Family maintenance – Support for dependants, such as an ex-spouse or child, is tax-free.

· Political donations – Tax-free if given to a party with at least two elected MPs or one MP with 150,000 votes.

Additionally, there’s an annual exemption of £3,000 (which can be carried over one year if unused) and a small gifts exemption, allowing unlimited tax-free gifts of up to £250 per person, provided no other exemption applies. Gifts exceeding these limits may be subject to inheritance tax.

What is Tapering Relief

Taper relief applies when the giver doesn’t survive the 7-year period. If they live at least 3 years, the tax is reduced on a sliding scale. This makes early gifting more beneficial. It is important to note that tapering relief will only apply to the portion of the gift that exceeds the nil-rate band.