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What is the “7-Year Rule” in inheritance tax and how can it decrease your tax liability after you die? PHR solicitors’ expert probate team explains.

What Is The 7-Year Rule In Inheritance Tax?

Inheritance tax is one of the most misunderstood aspects of dealing with someone’s estate and can cost your loved ones hundreds of thousands of pounds when you die if you don't plan carefully.

There are ways to minimise the inheritance tax bill, and an often overlooked technique is using the 7-year rule. Here, we explain what the 7-year rule is, and how inheritance tax planning can reduce the tax payable on your estate.

Research conducted by Opinium suggests that the majority of British over-55s wish to leave an inheritance when they pass away.

Their study also states that half of all adults are completely unaware of the 7-year rule when it comes to inheritance tax.

When you die you will likely pass on a number of gifts to your family or close friends. If you are making a financial gift in your will, you need to know whether the gift is tax-free, or whether it will create a tax bill.

This is why it is vitally important to understand the 7-year rule in order to ensure you can reduce any potential tax liabilities that may be imposed on your estate.

Below, we explain what inheritance tax is, what the 7-year inheritance tax rule entails, and how Percy Hughes & Roberts can assist with either drawing up a will, administering an estate after death or reducing how much inheritance tax your family will owe.

If you have any questions we have not answered, you can contact us by completing the enquiry form below or by calling 0151 666 9090.

What is inheritance tax?

Before we explain the 7-year rule, it is important to understand exactly how inheritance tax works. Inheritance tax, sometimes written as IHT, is a tax on the estate of a person who has died. It is a one-off tax that must be paid within 6 months of the death.

A deceased person’s estate is made up of their property, possessions, and money. Once the value of the estate has been calculated, you will need to work out whether inheritance tax is owed.

You must pay inheritance tax at a rate of 40 percent on anything above the nil-rate band allowance. The standard nil-rate band allowance is £325,000 per individual.

This means that the tax is only charged on the part of the estate that is above this threshold.

For example:

  • Your estate is worth £400,000. The tax-free threshold is £325,000.
  • The inheritance tax charged will be 40% of the difference, which is £75,000. In this scenario, the tax bill would equal £30,000.
  • Any unused amount within the threshold can be passed onto a surviving spouse or civil partner
  • This can potentially bring their nil-rate band up to £650,000.

This is in addition to the main residence nil-rate band (RNRB), which is an extra nil-rate band for married couples or civil partners when their estate includes a property that is being left to their children or other direct descendants.

The current level for residence nil-rate band sits at £175,000.

This is a notoriously complex area of law and we would advise getting expert legal help to avoid any potential pitfalls.

What is the 7-year rule in inheritance tax?

The 7-year rule in inheritance tax applies specifically to gifts. “Gifts” in this sense do not mean items that are wrapped in ribbon and paper, but something that has value more generally, i.e. possessions, money, and property.

While some gifts are exempt from inheritance tax, most gifts are subject to inheritance tax rules.

Taxable gifts can be split into two categories. Chargeable lifetime transfers (CLT), which relate to gifts that are paid into a discretionary trust, can be subject to an immediate 20% inheritance tax charge.

The second category, potentially exempt transfers (PET), is where the 7-year rule can become effective.

A PET gift can be completely tax-free if you live for 7 years after gifting it to an individual.

If you die within 7 years of gifting the asset, it will count towards the value of your estate and the £325,000 allowance.

After 7 years, the gift does not count towards the value of your estate, which is known as “the 7-year rule” for inheritance tax purposes.

If you give a gift and die between three and seven years after handing the asset over, the inheritance tax band is tapered on a sliding scale. This scale is:
 

Years between gift and death Tax paid
Fewer than 3 40%
3 to 4 32%
4 to 5 24%
5 to 6 16%
6 to 7 8%
7 or more 0%

 

This rule is why, very often, parents will give their children or grandchildren gifts long before they believe they will pass away, in order to avoid paying tax on the gift.

Gifts that are exempt from tax

If you think your estate is worth more than £325,000, it might be a good idea to start thinking about how to minimise the potential tax liability that your loved ones will have to deal with when you pass away.

One of the most straightforward ways to avoid inheritance tax is to consider giving away assets while you are still alive.

Below we detail the tax-free gifts you can start to think about:

  • £0 – Tax paid when gifting to a spouse or civil partner, including when you die
  • £0 – Tax paid on gifts given for the maintenance of old relatives
  • £0 – Tax paid on gifts to charities or political parties
  • £3,000 – Amount you can gift tax-free in a tax year, known as “annual exemption”
  • £5,000 – Amount you can gift tax-free to your children for their wedding
  • £250 – Amount you can gift tax-free to someone who hasn’t already benefited from your annual £3,000 exemption
  • 18 – Maximum age you can gift your children with maintenance for their education tax-free

Firstly, your civil partner or spouse will not pay any inheritance tax on assets gifted to them, even if it is within 7 years of your death.

This is because you are allowed to pass your estate onto the surviving partner when you die, tax-free.

You are also allowed to gift up to £3,000 in a tax year, known as an “annual exemption”. After this exemption, you can gift a further £250 to individuals who haven’t benefited from that initial £3,000.

A parent can gift their child £5,000 for their wedding, completely tax-free. You are also able to give gifts to charities and political parties without paying any tax.

Using gifts in this manner means you can start to reduce your tax liability and bring the total value closer to £325,000.

How can Percy Hughes & Roberts help?

At Percy Hughes & Roberts Solicitors, we have a team of dedicated wills and probate solicitors who are ready to help you resolve your query or issue relating to this area of the law as quickly and effectively as possible.

If you need help in dealing with writing a will in order to minimise tax, managing inheritance tax on an estate, or simply want guidance on inheritance tax more generally, our wills and probate solicitors have a wealth of experience.

They can assist you in this complex area of law and ensure you leave your loved ones in the best possible situation.

If you would like to contact one of our expert wills and probate solicitors you can do so by calling 0151 666 9090 or by completing the “Get in touch” form on this site.
 

Contact Percy Hughes & Roberts

To speak to an employment law solicitor for advice, contact Percy Hughes & Roberts for a no-obligation phone consultation today. We provide ourselves on offering expert advice that's easy to understand, and we will be with you through every step of the legal process.

Call us on 0151 666 9090, or fill out an online enquiry form to arrange for us to get in touch at a time that's suitable for you.

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