IHT lifetime gifts - the 7 year rule and alternatives if abolished

Understanding how inheritance tax applies to lifetime gifts is an important part of estate planning. The current rules offer potential opportunities for tax reduction via lifetime gifting, but potential changes which are being speculated on by the UK press mean many are considering alternative strategies.

The current 7 year rule

This provides a mechanism for lifetime gifts to gradually fall outside of inheritance tax assessment:

• Full amount gifted will be subject to IHT if death occurs within 3 years after gift made- any gifts made within this period are added back into the estate and taxed at the full 40% rate, using up the nil rate band first

• Tapered relief applies between years 3 and 7 - the tax rate reduces (tapers) on a sliding scale depending on how long the donor survives after making the gift.

• Complete exemption achieved after 7 - once this period elapses, the gift falls completely outside the inheritance tax net regardless of value

Taper relief

The sliding scale of tax reduction operates as follows :-

• 3-4 years - 20% reduction brings effective rate down to 32% on value above nil rate band for gifts made during this period

• 4-5 years - 40% reduction results in 24% effective tax rate on excess value, providing significant savings if donor survives this long

• 5-6 years - 60% reduction means only 16% tax payable on amount over threshold, making substantial gifts increasingly attractive

• 6-7 years - 80% reduction reduces tax to just 8% on value exceeding nil rate band, offering near-total relief

• After 7 years - 100% exempt with no tax payable regardless of amount, achieving complete removal from estate

Potential changes

Recent policy discussions have highlighted possible reforms to the system:

• Reduction to five years being considered - would simplify planning but potentially increase tax take by reducing the gifting window and removing the taper relief period

• Complete abolition proposed by some - more radical reform suggestions include removing all lifetime gifting reliefs and implementing an immediate tax charge system

• Increased focus on lifetime giving - some proposals advocate encouraging earlier wealth transfer through other incentives such as reduced immediate tax rates

• Simplified system proposed - options include flat-rate immediate charge on large gifts instead of wait-and-see approach to provide certainty

Uncertainty about estate planning

Potential changes create uncertainty for existing arrangements. It's unclear how existing gifts would be treated if rules change, particularly those within the current 7 year period.

We are finding that clients currently want to at least consider other IHT mitigation methods alongside gifting to spread risk

Alternative IHT planning options include :-

• Discounted gift trusts - inheritance tax reduction through actuarial calculation of gift value while retaining income through regular payments

• Loan trusts - allow future growth to pass outside estate while retaining access to original capital through loan repayment rights

• Family investment companies - corporate structure can facilitate controlled passing of value to next generation while maintaining influence

• Business property trusts - can hold qualifying assets to obtain business relief after two years of ownership.

• Business Relief - such as investment in qualifying assets , whether AIM shares, relief on qualifying business interests including partnerships and unquoted companies, agricultural property or commercial property structuring: Strategic holding of business premises to qualify for relief.

• Insurance Solutions - life coverage can provide funds for tax payment

• Pension Planning - such as ensuring benefits pass tax efficiently outside estate or pension bypass trusts

• Regular gifts

• Using exemptions efficiently - such as regular gifts from surplus income with proper documentation, annual exemption which is currently £3,000.00

Of course the difficulty is that if the current Government is intent on raising taxes vis inheritance, any of the above rules could also be changed.

Record keeping is essential

• Gift dates and values - detailed records of all transfers including supporting valuations.

• Source of funds - evidence of where gifted assets originated particularly for regular gifts.

• Recipient details - full information on beneficiaries and their receipt confirmation.

• Regular gift patterns - documentation supporting normal expenditure from income claims.

• Valuation evidence - supporting documentation for asset values particularly business interests.

• Regular review process - ongoing monitoring of compliance with various reliefs.

This overview covers key aspects of IHT planning. Specific advice should be sought for individual circumstances.