How to stay out of the 14-year inheritance tax gifting trap

As inheritance tax regulations tighten, more families are looking for ways to save money

It's common practice to give away money, but if done incorrectly, your loved ones could be responsible for paying HMRC for nearly ten and a half years.

Think that the seven-year rule is the only thing you need to be concerned about when making gifts to avoid inheritance tax? Think again. A small known anomaly in the system can lead to an HMRC investigation that can recover taxes for up to 14 years.

According to reports, chancellor Rachel Reeves intends to tighten the regulations on gifting during an individual's lifetime, which has sparked new inheritance tax (IHT) concerns. Giving gifts is one of the most popular ways to get around inheritance tax.

According to reports, the proposals being considered would limit the amount of lifetime gifts that can be passed on IHT-free and examine the taper relief rules, which currently lower the amount of inheritance tax owed from 40% to 0% after seven years.

If you pass away and live for seven years, the so-called "seven year rule" states that the gift is outside your estate for the purposes of IHT, which means the recipient is exempt from paying inheritance tax on it after your death.

The taxman may, however, look into gifts you made up to 14 years ago and demand inheritance tax be paid on them if you give to a trust, which is becoming a more common financial planning tactic.

The head of estate planning at Evelyn Partners, a wealth management company, Ian Dyall, stated: "Most people are unaware of how complicated the inheritance tax treatment of giving is.

"A lot of people think that gifts can be disregarded after seven years have passed since they are given. While gifts given to trusts up to 14 years prior to a person's death may have an impact on the total amount of tax due, this is only true for outright gifts to individuals.

Other strategies to lower your IHT bill and common IHT myths are covered in separate articles.

How does the fourteen-year IHT rule operate?

The tax code does not contain a separate 14-year law. The phrase refers to the fact that, in some circumstances, if a person passes away within seven years of making a gift, HMRC may be required to retroactively calculate inheritance tax for up to 14 years under the current seven-year rule on gifts.

"If you give away something and live for seven years, it's outside your estate for inheritance tax purposes," explained Jude Dawute, managing director of wealth manager Benjamin House.

"The gift is counted back in and up to 40% tax may be owed if you pass away within seven years.

If the last surviving parent is transferring assets to their children, the gift will first lower the inheritance tax-free allowance, also known as the nil rate band, which may be as much as £1 million. This will be available to the estate's executors as they determine who is responsible for what in terms of IHT.

The recipient of the gift is responsible for the inheritance tax due on the gift after the tax-free threshold has been fully utilized, which means the nil rate band has been lowered to zero. However, a provision known as taper relief causes the rate that would apply to the gift to gradually decrease.

If you had previously made a chargeable lifetime transfer (CLT), usually a gift into a discretionary trust, before that gift, that is when the 14-year rule applies.

"Gifts to trust are treated slightly differently," Dyall stated.

First, if the value of the gifts to the trust surpasses the nil rate band when added to any other gifts to the trust made within the preceding seven years, there may be an inheritance tax liability at the rate of 20 percent at the time of the gifts.

"Again, the trustees of the trust will not be held liable if the donor lives for seven years following the transfer to the trust.

But the gifts don't go away. When determining the liability on any gifts given during the last seven years of the donor's life, their worth will be considered.

A gift to a trust (a CLT) made within seven years of your later gift to a person (a potentially exempt transfer, or PET) and your death within seven years of the PET are therefore included in the calculation by HMRC.

"When calculating the tax, they're essentially looking at gifts given up to 14 years prior to your death," Dawute explained.

Take the following example.

In 2015, you contributed 300,000 to a trust (CLT). In 2021, you gave your daughter (PET) 200,000. You pass away in 2025, four years after the PET. Since you passed away within seven years of the PET, HMRC also considers the 2015 trust gift. A larger portion of the subsequent gift may be subject to taxation because the earlier trust gift may have already depleted your tax-free allowance (nil-rate band).

How to get around the 14-year rule on inheritance taxes.

It is best to keep large gifts to trusts seven years and a day apart from large gifts to individuals in order to avoid the effects of this 14-year inheritance tax rule.

Dawute also advises utilizing your inheritance tax gift allowances to the fullest extent possible.

Wedding gifts: up to 5,000 to a child, 2,500 to a grandchild or great-grandchild, and 1,000 to anyone elsegiven in connection with their marriage or civil partnershipare exempt from IHT, as are regular gifts from surplus income (as long as they don't lower your standard of living). You can also think about life insurance. 3,000 per year (plus one year's carryover) and the 250 small-gifts allowance per person are free of IHT. A trust-written gift-inter-vivos life policy can reduce tax risk for seven years following a sizable gift.

Furthermore, rather than giving to trusts, which do not, it might be worthwhile to think about giving outright gifts, which vanish after seven years.

According to Dyall, trusts are a very helpful way to safeguard gifted money while maintaining some control over it. However, in many situations, this control is superfluous and limits your ability to reduce inheritance tax.

The largest obstacle to reducing your inheritance tax obligation is attempting to keep control of your assets. As a result, people stop planning too late and give less during their lifetime.

"It's crucial to consider whether you really need all of your possessions and whether maintaining control or protecting them is absolutely required, as doing so may result in higher inheritance tax costs.