Death, particularly our own, can be an uncomfortable subject. But comfortable or not, the sooner you start thinking about and planning for the inevitable, the better a position in which you will be leaving your loved ones.
Knowing how to navigate the various rules, thresholds, and allowances of Inheritance Tax (IHT) is an essential aspect of intergenerational wealth planning. Understanding them, even a little, will help you decrease the size of the unpleasant bite IHT takes from your legacy. The 7-Year Rule is perhaps one of the most important of these.
What is the 7-Year Rule?
On its face, the 7-Year Rule is very simple. Any gift given 7 or more years before the benefactor’s death will be completely tax-free, providing the gift is not part of a trust. Of course, as with all laws surrounding tax, it’s not entirely as simple as it first sounds. There are caveats, and conditions, but they’re easy enough to plan around, providing you start as early as you can.
What is a “Gift”?
A “gift” is defined by HMRC as anything of value, such as money, property, stocks & shares, or anything else of monetary worth. Additionally a gift may also be a loss of value; for instance if you sell your house to loved ones at under the market value, the difference in value will be counted as a gift.
IHT on gifts will usually be paid by the estate until you have given away a total of £325,000 in gifts in the 7 years before your death. Once you have exceeded this amount the burden of the tax bill will then fall to the beneficiaries.
It is important to keep a record of the gifts you give, their value, and when you give them. This will be beneficial both for your own peace of mind and to the eventual executor of your estate.
Gifts with Reservation
One key exemption of the 7-Year Rule is a ‘gift with reservation’. This is an asset that you give away but still continue to benefit from. For instance, you cannot simply sign over your home to a relative and continue to live there without paying them rent at the market value. Such assets will be counted towards the value of your estate even after 7 years have passed.
Are there Allowances for IHT and the Seven-Year Rule?
There are several minor allowances that allow you to give away modest gifts each tax year which will not be factored into the value of your estate and do not need to be factored into the 7-Year Rule. These include an Annual Exemption of £3,000, Wedding Gifts of up to £5,000 for a child and smaller amounts for others, a Small Gift allowance of £250, and unlimited regular payments to help with another person’s cost of living.
As with standard IHT, any number of gifts of any amount may be given to a legal spouse at any time before death without IHT or the Seven-Year Rule applying. The same is true of gifts made to charities and political parties.
The specifics of these allowances can be found on the government’s website or discussed in depth with one of our advisors.
Taper Relief
Taper relief refers to how the rate of tax on the gift will decrease the more time passes between the gifting and the death of the benefactor. So even if you don’t make it the full 7 years after giving away an asset, there may still be some reduction in the tax bill. Gifts will be taxed at the usual 40% for the first 3 years, 32% for between 3-4, 24% for between 4-5, 16% for 5-6, 8% for 6-7, and finally falling to 0% at that all-important 7 years.
It is important to note that the £325,000 threshold for total gifts given once again applies here.
What if I don’t think I’ll make it 7 Years?
If you don’t like the look of your chances at lasting 7 years, there are other investments to consider, such Business relief (Br) which can mitigate the tax after 2 years. Br can appear intimidatingly complex when first approaching it, but it is a useful investment that our advisors are happy to talk you through, should you wish to be fully aware of your options.
How Should I Be Using the 7-Year Rule?
Being mindful of the 7-Year Rule doesn’t mean you need to be offloading all your assets as early as possible, particularly with the rules on gifts with reservation preventing you from enjoying them. The point of intergenerational wealth planning is to achieve a life well lived, both for you and your loved ones. This can’t be done if you’re too worried about IHT eating away parts of what you have now to enjoy them in the moment.
All being aware of the 7-Year Rule means is knowing what assets you can afford to give up early, when to do so, and whom to give them. Too much wealth can be lost between generations when the 7-Year Rule is not properly utilised, and the tools for doing so are readily available.
If you would like to discuss any of the topics we have covered in this article, you can contact us by telephone on 02920 782330 or by email at theteam@uniqfamilywealth.co.uk.
