Tax-efficient gifts and the seven-year rule

Making financial gifts to your loved ones could make a big difference to their financial security and wellbeing. It could also be more effective for inheritance tax (IHT) planning purposes to gift money while you’re still alive than to pass it on through your will when you die.

Understanding how lifetime gifts are taxed is crucial. The rules can be complex and, if you make a mistake, you could end up passing on a smaller legacy than you intended.

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Tax-efficient gifts

There are some gifts that are completely exempt from IHT, such as gifts between spouses or civil partners, and gifts to charities and political parties.

Other gifts may also be exempt, but only if they are within your gifting allowances. These include:

• Gifts of up to £3,000 each tax year – this is known as your ‘annual exemption’ (see below)
• Gifts for weddings or civil partnerships – each tax year you can give up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, or £1,000 to any other person
• Gifts from regular income
• Small gifts of up to £250 per person per tax year (so long as you haven’t used up another allowance on the same person).

Gifts aren’t just money, but also include household and personal items (such as jewellery and antiques), a house or land, shares listed on the London Stock Exchange, and unlisted shares you held for less than two years before your death.

Your annual exemption

You can give away a total of £3,000 worth of gifts each tax year without this counting towards the value of your estate. You could gift the whole £3,000 to one person or split it between several different people.

Any unused annual exemption can be carried forward by one tax year. For example, if you only used £2,000 of your annual exemption in the last tax year, you could carry forward £1,000 to the current tax year.

Potentially exempt transfers and the seven-year rule

There may be instances where you wish to make a larger financial gift to someone – to pay your grandchild’s university tuition, for example, or to help them onto the property ladder. This type of gift is known as a ‘potentially exempt transfer’, and you must survive for at least seven years for it to be tax free. Gifts to some types of trusts are treated differently and may be immediately chargeable to IHT.

Potentially exempt transfers made within the seven years before you die reduce your IHT ‘nil-rate band’ – this is the amount you can pass on to your beneficiaries free of tax. The nil-rate band is currently £325,000. So, if you gave your child £200,000 and died within seven years, you would only be able to pass on £125,000 of your estate tax free after your death.

What’s more, if you gave away more than £325,000 in the seven years before you died, you would not only eliminate your nil-rate band, but anyone who received a gift above this threshold would have to pay IHT. The rate of tax would depend on the number of years between the date of the gift and your death:

Years between gift and death	Rate of tax
0 to 3 years	40%
3 to 4 years	32%
4 to 5 years	24%
5 to 6 years	16%
6 to 7 years	8%
7 or more years	0%

Source: HMRC

If, for example, you gave your grandchild £500,000 and died two years later, they would have to pay £70,000 in IHT (40% of £175,000). Whereas if you made the same gift and died five to six years later, your grandchild would pay £28,000 in IHT (16% of £175,000). Remember, a gift of this size would also eliminate your IHT nil-rate band.

It’s really important to keep a record of any gifts you make, including what you gave, who you gave it to, its value and the date you made it. This will help the executor of your estate work out what gifts you made in the seven years before you died.

Next steps

A carefully considered lifetime gifting plan could enable you to make a real difference to your child or grandchild’s financial security. But the rules are complex and it’s important to seek expert advice. A financial adviser can help you pass on your wealth securely and efficiently, taking into account your unique needs and using all the allowances and structures that are available to you.

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The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.