The 7-year rule in inheritance tax

Inheritance tax used to only affect the super wealthy. But now, thanks to soaring house prices and stock markets, even regular families who aren't mega rich can get slapped with big inheritance tax bills on their estate.

As per HMRC, approximately £7.1 billion was paid in inheritance tax during the fiscal year 2022-23. That’s up by around £1 billion compared to the previous year. Not a bad little earner for the state.

So it makes sense that more of us want to get a handle on how we can reduce our inheritance tax exposure. One way to potentially lower your inheritance tax liability is through the 7-year rule.

The 7-year rule allows you to give away assets during your lifetime without incurring inheritance tax on gifts, as long as you survive seven years after making the gift.

Don’t worry, it’s all above board… here's how it works:

What gifts are covered by the 7-year rule?

• Any gifts made during your lifetime to individuals or bare trusts. This includes gifts of money, property, possessions or investments.
• Gifts into most types of trust other than bare trusts. These include interest in possession trusts, discretionary trusts and accumulation trusts. The exception is gifts into certain trusts for disabled people.
• Assets gifted that later increase in value – as long as the gift was made outright to the individual. For example, if you gift shares that later increase in value, the growth is outside of your estate provided you live seven years.

What gifts are exempt from the 7-year rule?

• Potentially exempt transfers into most trusts – these may attract inheritance tax if you die within seven years.
• Gifts to your spouse or civil partner – these are exempt from inheritance tax even if you die within seven years.
• Gifts of up to £3,000 each tax year – you can give away £3,000 per tax year exempt from inheritance tax even if you die within seven years.
• Small gifts under £250 – other gifts under £250 per person per tax year are exempt.
• Gifts that are regular from surplus income – these are exempt provided you can maintain your standard of living after making them.
• Certain gifts around weddings – each parent can give cash or gifts worth £5,000 tax-free for a child marrying, while grandparents can give £2,500 and anyone else £1,000.

What is the inheritance tax 7-year rule?

If you die within seven years of making a gift covered by the 7-year rule, taper relief applies so that inheritance tax is charged as follows:

• Death within 3 years - 40% inheritance tax payable
• Death between 3 and 4 years - 32% inheritance tax payable
• Death between 4 and 5 years - 24% inheritance tax payable
• Death between 5 and 6 years - 16% inheritance tax payable
• Death between 6 and 7 years - 8% inheritance tax payable
• Death after 7 years - 0% inheritance tax payable (gift is fully exempt)

The 7-year clock starts when you make the gift, not from the date it was valued. Planning to survive at least seven years after making substantial gifts can therefore help reduce inheritance tax.

Making use of the annual tax-free allowances each year is another smart tactic. But take care not to fall foul of the rules against gifts meant to dodge tax.

Get professional advice so your gifts are structured properly – it’ll give you some much-needed peace of mind, too!