Is your financial gift tax-free or is it going to incur a tax bill now or further down the line?
Inheritance Tax laws in the UK can be confusing. But, if you want to avoid paying a large lump sum in taxes, you’ll need to familiarise yourself with certain exemptions, including the 7-year rule in Inheritance Tax law.
What is the 7-year rule in inheritance tax?
Let’s dive in.
The 7-year rule is a tax exception rule in Inheritance Tax law, which states that a gift is completely tax-free if it was given 7 years before the benefactor’s death.
The rule was put in place by HMRC to prevent people from avoiding an Inheritance Tax bill after giving all of their money away on their deathbed. It doesn’t apply when the gift is part of a trust.
Understanding the 7-year rule in Inheritance Tax can help you plan your financial gifts, including money, property, and assets, properly and make sure that everyone makes the most out of them.
Inheritance Tax is a tax owed on the estate (ex. Possessions, property, and money) of a person who has died. According to HMRC, the Inheritance Tax is paid by the beneficiary (the person that inherits the estate). It’s a one-off tax that they need to pay within 6 months after the benefactor’s death.
Currently, the nil-rate band is £325,000. This means that if the value of the estate is below this amount, you won’t have to pay any Inheritance Tax.
When it comes to Inheritance Tax and the 7-year rule, the trickiest thing to plan for is asset growth.
Namely, if you receive taxable assets and they increase in value by the time the tax is due, they might be subject to Inheritance Tax. For example, if you bought a house for £300,000 and it was valued at £400,000 at the time of your death, the £100,000 increase in value would be added to your estate for Inheritance Tax purposes.
HMRC defines “gift” as anything of value (i.e. belongings, money, property), or a loss of value that occurs when something is transferred. For example, if you sell a home for less than it’s worth to your children, the difference in value is considered a gift.
However, not all gifts are taxable.
Inheritance Tax on gifts doesn’t apply for:
Taper relief is a tax relief that’s applicable to gifts given in the 3-4-year period before a benefactor’s death. It determines how much a beneficiary needs to pay in Inheritance Taxes.
|Years between gift and death||Rate of tax on the gift|
|3 to 4 years||32%|
|4 to 5 years||24%|
|5 to 6 years||16%|
|6 to 7 years||8%|
|7 or more||0%|
Gifts received in the 3 years before the benefactor’s death are taxed at 40%.
The most well-known exemption in inheritance tax is the “annual exemption,” which allows all UK residents to give tax-free gifts on an annual basis. The HM Revenue and Customs limits the annual tax exemption for all UK residents to £3,000.
What is the 7-year rule in inheritance tax? It’s a tax rule that states all inheritance beneficiaries have to pay a one-off tax on an estate (money, assets, and property) they’ve received from a benefactor within 7 years of their death. The amount beneficiaries have to pay depends on how much time has passed since the benefactor’s death.
My name is Marija, and I'm a financial writer at DontDisappointMe. Although finance might not be everyone's cup of tea, my 10+ years of working in one of the biggest banks in my country, and my interest in extensive research on everything finance/investment-related, have made me somewhat of an expert in the field (if I do say so myself). No longer having the passion to work in a corporate setting, I decided that I couldn't let all of this knowledge go to waste so I started writing. And, here I am! Today I try to share my knowledge with my audience in the hopes of making this topic as simple and interesting as possible. In my leisure time, I like spending time with my family and travelling to new locations.