What is the 7 year inheritance tax rule and how does it help cut your bill?

Brits concerned about leaving a hefty inheritance tax bill behind for loved ones can take advantage of a legal loophole – known as the 7 year inheritance tax rule – that lets them give away as much cash as they like tax-free.

The rule is described by experts as a “cornerstone” of inheritance tax (IHT) planning. While inheritance tax receipts collected by the government are soaring, it is a smart way to reduce your IHT bill.

The basics are simple. You can gift as much as you like during your lifetime without it being subject to IHT – as long as you live for seven years after making the gift.

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Alex Race, financial planner at Rathbones, said: “If you die within that seven-year window, the gift may be counted as part of your estate and could be subject to inheritance tax, depending on its value and whether you have enough of your nil-rate band (currently £325,000 per person) available to cover it.”

The rule is designed to prevent people from giving away large sums on their deathbed to avoid inheritance tax. It is reportedly in the sights of chancellor Rachel Reeves, who is said to be planning on tightening the rules on gifting during an individual’s lifetime.

“But with careful planning, the seven year rule can be a powerful way to reduce the value of your estate and, ultimately, your IHT liability,” said Race.

We look at the 14 year IHT gifting rule in a separate article.

What is the 7 year rule for inheritance tax?

The seven year inheritance tax rule works on a sliding scale – if you die within seven years of making a gift, IHT may still apply. But the tax charge reduces the closer you get to the seven-year mark.

This is known as taper relief. It can significantly cut the tax bill on gifts that exceed the nil-rate band.

Here’s how the taper relief scales:

• 0–3 years: 40% full IHT rate
• 3–4 years: 32%
• 4–5 years: 24%
• 5–6 years: 16%
• 6–7 years: 8%
• 7+ years: 0% gift fully exempt from IHT

“It’s worth noting that taper relief doesn’t reduce the value of the gift itself – it only reduces the tax payable,” said Race.

Taper relief only kicks in for gifts above the nil-rate band – which is £325,000 per person – because there is no inheritance tax due on gifts below the nil rate band.

“So if you’re planning to pass on significant wealth, timing is everything,” Race said.

How does the 7 year rule work in practice?

Timing gift giving will be unique to each family. But we look at a few scenarios where Rathbones has pointed out the seven year rule would apply.

1. Late gifting to children

Imagine someone gifts £100,000 to their children at age 78, hoping to reduce their estate. If they pass away five years later, that gift falls within the seven-year window and could be subject to IHT – potentially up to 24%, depending on the nil-rate band and other gifts made.

2. Misunderstanding exemptions

A person believes their £3,000 gift is covered by the annual exemption – where everyone is allowed to give away up to £3,000 inheritance tax-free – but in actual fact they’ve already used it that year. Where they die within seven years, the gift is added to their estate for IHT purposes.

3. Gifting from capital, not income

Regular payments to a child are made from savings, not surplus income. The donor dies within seven years, and because the gifts weren’t from income, they don’t qualify for the surplus income rule – in which they are exempt from IHT – and so are potentially taxable.

How to avoid being caught by the 7 year rule

Katherine Waller, co-founders of wealth manager Six Degrees, said of the most common challenges when it comes to the seven year rules she sees is around record keeping.

“HMRC requires executors to produce exacting and comprehensive records relating to the timing and value of any gifts given, and in our experience it can be incredibly burdensome and bureaucratic to unpick,” she said.

Other ways people can avoid being caught by the seven year rule, Rathbones said, include:

Starting early: The sooner you begin gifting, the more likely you are to survive the seven-year period. This is especially relevant for those looking to pass on wealth to children or grandchildren.

Using exemptions: Annual gift allowances – such as the £3,000 annual exemption and small gift exemptions – are immediately outside your estate and not subject to the seven-year rule.

Regular gifting from income: Gifts made from surplus income (not capital) that don’t affect your standard of living can be exempt from IHT, even if you die within seven years – provided they’re regular and well documented.

IHT and the problems with gifting

Gifting is a useful but often irreversible IHT planning strategy that requires careful thought. According to wealth firm Six Degrees’ co-founder Waller it is “incredibly common to see divergent views on gifting within couples”.

“One parent may, for example, wish their child to graduate university debt-free, while the other may believe a student loan helps the child understand the value of a degree and drives better behaviours,” she said.

Large gifts can have a potentially negative impact on a child or young adult. But under the seven year rule, money can be gifted out of the parents’ estates but remain either within the control of the parents, or at the very least, not under the control of the child, Waller said.

Setting up as ‘family investment companies’ or trusts, can enable this kind of indirect gifting.

Waller said she has also recently met several couples eager to begin gifting to their children, but without first establishing how much is enough for them.

“Gifting too much, too soon, can create problems later on,” she said.

"Once you factor in the rising cost of care – which is already extremely high and tends to outpace general inflation by several percentage points – there’s a real risk of creating a shortfall in later life. In some cases, that can even turn into a financial burden on the very children the gifts were intended to help."