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Written by Emily Cross.
19 minute read
When someone you love dies, dealing with the financial and legal side of things may feel overwhelming. At a time when you understandably want to grieve and begin to process your emotions, feeling like you’re being thrown into an unfamiliar world with seemingly endless rules and paperwork may feel like too much at times. Our goal with this guide is to provide a single resource you can refer back to when you feel ready and when you need to.
Inheritance tax — the tax paid by your loved one’s estate when they die — is a complex issue with a number of key things you may need to be aware of. One of the most important is the 7-year inheritance tax rule, as it determines how much tax needs to be paid on gifts your loved one made when they were still alive. We want to help guide you through how it works with the aim of making the process a little more accessible.
Here at Aura, we believe the help you get should never stop with an online guide or a kind word. Our experience lies in the world of prepaid funeral plans and direct cremation, and we can help you with every aspect of them when you feel ready. We can also help you compare funeral plans so that you find something that you feel suits you best.
Key takeaways:
An estate is the sum total of the money, property, and other belongings and valuables that your loved one leaves behind when they die. An inheritance tax of 40% is applied, so it is natural for many people to think about how they can protect their assets against this levy and plan ahead. Gifting is one of the most common ways to do this.
A gift in the legal sense means giving something to someone else, whether directly or by placing it within the confines of a trust. Giving a gift will reduce the total value of the estate, therefore making it liable to pay less inheritance tax. There are, however, some caveats on this point.
Chief among them is the fact that the 7-year rule comes into play if your loved one dies within 7 years of giving the gift. If they do, the gifts may not be completely exempt from inheritance tax. Because of the complexities of the tax system and the fact that there are so many possible permutations and combinations, we are going to focus on general cases and common scenarios.
If your loved one lives more than 7 years after making the gift, the gift will be exempt from inheritance tax in the vast majority of cases. If they live less than this, a sliding scale of inheritance tax referred to as ‘taper relief’ will be applied. There are also different classes of gifts that you may need to be aware of.
A common example of PET is if your loved one gave you a cash gift directly rather than placing it inside the confines of a legal trust. They are giving it to you to spend as you see fit, and it will become exempt from inheritance tax if they live longer than 7 years after the date the gift has been finalised.
An example of a CLT would be if your loved one placed money or property into a trust. In this case, the asset is to be ‘immediately chargeable to inheritance tax,’ which means that although you do not automatically have to pay tax on it, it will need to be assessed to see how much inheritance tax is due.
We completely understand that these types of legal distinctions may feel confusing or overwhelming, especially at a time when you may be trying to figure out how to deal with grief. For this reason, you may find it helpful to connect with a local tax planning specialist who can guide you through everything you need to know about your specific case.
The simplest way to outline the 7-year rule is that if your loved one dies within 3 years of giving you the gift, it will have the full rate of 40% applied to it, but if they die more than 7 years later, the inheritance tax will not be charged. During the 3-7-year window, a sliding scale of tax is applied that is known as ‘taper relief’.
When someone gives a gift (like money or property), and then passes away within 7 years, that gift may be subject to inheritance tax.
Normally, if the person dies within 3 years of giving the gift, the tax on that gift can be up to 40%.
But if they survive longer, the tax reduces over time — this is called taper relief. According to HMRC’s guidance, you can think of it as a sliding scale that gradually reduces the amount of inheritance tax that is due in proportion to the lifetime of the donor:
Applying taper relief may prove difficult if multiple recipients need to be contacted, and if proof of the date on which the gift was made does not prove to be forthcoming. Contacting a tax specialist can help reduce the stress and time spent so that you can focus on processing the death of your loved one.
Putting aside the complicated legal designations for a moment, the two main types of gifts that are typically made are property and money. Giving away one or both is a legal way to reduce the size of the estate and, therefore, minimise its inheritance tax liability.
Some reading this may decide to take a strategic approach to tax planning. In this case, there are a series of annual allowances not subject to the 7-year rule.
According to HMRC, there is an ‘annual exemption’ of £3,000 that can be given to an individual or split between multiple individuals. HMRC also states that every tax year, you can give wedding or civil ceremony gifts of £5,000 (children), £2,500 (grandchildren and great-grandchildren), and £1,000 (anyone else). In addition, they also state that you can give unlimited £250 gifts to people whom you have not used another benefit on during the same tax year.
If you give a gift to a charity, your spouse, or your civil partner, the entire amount will be exempt from inheritance tax.
If you give money or property to someone else to use as they see fit, including giving them the right to sell it at any time, you are making an outright gift. No conditions are attached, and legal ownership is transferred at the moment the gift is made.
Gifts made into a trust are more complicated because the trust and the person who manages the trust (trustee) will legally own it. Trusts are typically used when you want to give someone a gift but maintain a degree of control over when they can access it and how they can use it. A common example would be a parent or grandparent leaving property and savings to a child or grandchild who is not yet of adult age.
Another type of gift that you may hear about is a gift with reservation of benefit. A common example would be if your loved one gifted you a property but then continued to live in it rent-free until they died. While you may own the property, your loved one is clearly continuing to receive some form of benefit from the property, as they are still living there.
Gifts of this sort can be deemed part of the estate at the time your loved one dies and, therefore, may still be liable for inheritance tax. Contacting a tax planning professional can help you to understand your options and liabilities in what can quickly become a complex, time-consuming matter if you attempt to figure everything else out by yourself.
Although a tax professional can help you determine the total liability, you may find that learning a little more about how to value an estate can help illuminate the process. An accessible example is to take a closer look at how taper relief is applied to a gift.
For reference, here is the taper relief table reproduced from an earlier section of this guide:
Let’s take an example of a £10,000 cash gift that was made on 3rd March, 2020. Your loved one died on August 7th, 2024, and you want to know how much inheritance tax will be applied. Because they have died within 4-5 years of making the gift, a 24% inheritance tax applies. This means that the inheritance liability on the gift will be £2,400.
In the vast majority of cases, the person who is handling the estate (the executor named in the will) will be responsible for ensuring that the inheritance tax is paid. The money to pay the inheritance tax bill will come out of the remaining estate, not the personal finances of the executor. There are a small number of cases where this may not apply, however.
In some cases, the responsibility will shift to the recipient of the gift if the donor of the gift dies within 7 years, but there will also be many instances where this is not the case. You may find that the best approach, given the complexities of the UK tax system, is to contact a trusted independent tax advisor. They will then be able to guide you through everything you need to know about your individual case.
Another complicating factor is that the transfer of liability for the payment of inheritance tax does not happen automatically when the donor dies. If your loved one dies within the 7-year window, you have a legal responsibility to report the size, nature, and date of the gift to HMRC. Because HMRC understands the potentially complex nature of such arrangements and how you, understandably, have many other things to focus on, a 6-month reporting period is in place. That said, failure to report gifts on time can result in financial penalties.
You may also be liable for other forms of tax applied to the gift. A common example would be if you were gifted a property that you then choose to rent out to a tenant. You will have to pay tax on the rental income you generate as a result of this arrangement.
Knowing who pays the inheritance tax can help you plan other financial matters, such as whether you need to think about how to pay for funeral expenses. We also have a guide that can help you understand the details surrounding next of kin & funeral costs, which you may wish to read when you feel ready.
Many families choose to try to legally minimise their inheritance liability so that as much of the estate as possible can be passed down. Some find that strategic gifting where a plan is drawn up to utilise the various allowances can help.
If you wish to pass on much larger assets to your children, for example, you may wish to take a closer look at how to set up a trust. The trust will act as a legal entity that has legal ownership of anything you put in it and separates out who owns an asset from who can benefit from it.
Trusts are particularly common with parents and grandparents who want to put large amounts of money or property to one side in a tax-efficient manner while maintaining overall control of how they are used. If your children are not yet of adult age, for example, this will ensure that your assets are looked after until such a point where you feel your children are old enough to be fully responsible for them.
Setting up a trust can be a complex and time-consuming process that involves a large number of legal nuances and requires careful consideration. Hiring the services of a professional tax planner may help you to get everything set up as you wish in a way that is far less stressful than attempting to do so by yourself.
A tax professional will also help you keep comprehensive records of any gifts that are made, ensuring that you can easily see when a gift was made, to whom it was made, and how much it was for. This is essential when it comes to settling the balance of the estate and making sure that all inheritance tax liabilities have been paid in full.
The tax system, by its very nature, is a complex and often convoluted system, and it may feel overwhelming if you are also trying to process a loss or come to terms with the deteriorating health of a loved one. To this end, HMRC offers a dedicated service for those making inheritance tax enquiries.
There are a couple of things you may wish to be aware of that could go some way to demystifying how the system works:
You may also be interested to know that there is a way you can gift unlimited amounts of money without ever having to pay inheritance tax. The conditions on this statement are that the money you are gifting does not come from your estate and must instead come from excess income that you are generating. This means that you cannot liquidate assets (sell your home or car, for example), nor can you gift savings or cash in any shares you may own. Giving away the money must not diminish or negatively impact your quality of life in any way.
Dealing with legal and financial issues can be overwhelming at the best of times, and this is something that you may well find is amplified when you are coming to terms with the death of a loved one. To show you that you are never alone when dealing with such complex matters, we would like to share a few things with you that we encourage you to keep in mind:
Our goal is always to provide help and support during what we appreciate may be a difficult, emotionally challenging time. We hope that by taking a look at some of the details and key points around the 7-year rule, you have seen that it is something that is more accessible and easier to deal with than you perhaps first thought.
Many families choose to read guides like this as a way of gaining a working understanding so that they can hire a tax professional with peace of mind. Finding someone you feel is helpful and easy to deal with can help you navigate the complex world of the UK tax system at a time when you understandably have many other things on your mind.
We are always here when you need us and are constantly expanding our range of guides and articles so that you can find simple explanations from a team you can trust.
If you have any questions, would like a brochure or simply would like a chat through our services, our award-winning team is here to help.
Unlike other providers, we won’t hassle you with constant calls. We’ll simply ensure you have the information you need and leave you to come to a decision in your own time. When you’re ready for us, our team will be ready to help.
If you live for 7 years or more after giving a gift (usually either money or property), and that gift has not been placed in a trust, there will be no inheritance tax due on the gift in most cases. Because of the complex nature of the UK tax system, you may wish to consider checking everything with an independent tax professional. There is always the possibility that they will notice a loophole, exception, or even an area where you can pass on your estate in a more tax-efficient manner.
In most cases, provided the donor of the gift lives for 7 years or more, you will be able to avoid inheritance tax on early gifts. This is one of the primary reasons why many families choose to hire a tax planner so that they can structure their affairs in advance and have the peace of mind that comes from knowing they are prepared for many different eventualities.
One key point to note here, however, is that HMRC does have a degree of discretion when it comes to determining whether a gift is ‘reasonable’ in relation to your circumstances. This means that gifts which are unusually large and not made to a spouse or civil partner will be subject to an additional layer of scrutiny. If they decide that your gift is too large, they will tax you on the amount they deem to be unreasonable.
If you die within 3-7 years of making a gift to a loved one, a sliding scale of inheritance tax will apply, which decreases the 40% inheritance tax rate in proportion to how long you have lived. This is done so that you do not have instances where people who die a day short of the 7-year period are charged the full 40% inheritance tax while those who die just 24 hours later pay nothing.
Property can often be a more complicated type of gift to manage than cash. It is not uncommon for a home to be gifted to a loved one under the express agreement that the donor is allowed to live in it rent-free for the remainder of their life. While the home will then pass fully to the recipient upon the death of the donor, the donor is clearly deriving some benefit from the property while they are still alive. This is different from the case where the property was signed over in full, and no one was living in it.
The value of the property, the terms of the gifting agreement, and any other assets that are being redistributed from the estate to recipients also need to be considered when calculating the inheritance tax due. You may find that the least stressful approach is to hire a tax professional who will be able to talk you through your options and choices so that you don’t have to try and figure out everything by yourself.
Trusts can help shield assets from tax in a variety of different ways, but this doesn’t mean that they set the tax rate to zero. If assets are placed into a trust that are intended to be gifted to loved ones, and the donor dies within 7 years of the original transfer into the trust, the inheritance tax rate will be 40%. A tax professional will be able to advise you on how you could swap this for a guaranteed reduced rate of 20% if you pay the inheritance tax before you die. This is something that high-value estates often consider because it reduces the size of their estate while simultaneously reducing the amount of inheritance tax that needs to be paid.
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