Most people have vaguely heard that if you make large gifts, you then need to live 7 years. Sometimes that is the full extent of the understanding about this – and sometimes people know a little more; sometimes they understand it fully and sometimes they have a confused understanding.
Luckily, it is relatively easy to clarify what the ‘7-year rule’ is all about and when you need to
worry about it.
The good news is that if it is unlikely there will be Inheritance Tax to pay when you die then the 7-year rule is irrelevant to you. This is the starting point when considering gifting money and assets. Do what you like from an Inheritance Tax angle as there would never be an issue with this, and therefore it doesn’t matter how long you live after making large gifts.
There can be things to think about from another angle but more about that later…
When Inheritance Tax may be due
As a very simple summary – every individual can currently leave £325,000 tax free. If you own a property and will ultimately be leaving it to children, stepchildren or grandchildren there is an additional £175,000 allowance (Residence Nil Rate Band). Meaning that parents who own a property can usually leave £500,000 tax free (anything above that level is taxed at 40%).
If you are married, Inheritance Tax often doesn’t need to be worried about when the first one in a couple passes away; something called ‘spousal exemption’ applies to anything passing to the survivor, and then when the second one in the couple dies as well, they can use the Inheritance Tax allowance of the first to die – so as a general rule a couple can leave £1million of joint assets without Inheritance Tax having to be paid.
The 7-year rule where Inheritance Tax is likely to be due
This is where it gets a bit more complicated; understandably people who have a lot of assets often want to avoid their family ending up with large Inheritance Tax bills and losing a lot of money to the government. They also want to see their family benefitting from, and enjoying gifts, so they want to make gifts while they are still there to witness that enjoyment. Small gifts are always allowable from an Inheritance Tax angle but for gifts above the thresholds set out in the gifting legislation, the 7 -year rule will apply to those gifts.
Basically, the theory behind the 7-year rule, is that if you live for 7 years after you’ve given assets/money away then the asset/money will no longer form part of your estate when calculating if Inheritance Tax is due when you die. Instead, it is treated as belonging to the person you made the gift to.
What happens in the intervening period from gifting to the date when 7 years has passed?
You can check out the full details in our factsheet. To summarise, however, the gift is treated as belonging 100% to the person who has made it until 3 years has passed. After that, in years 4 to 7 the gift is increasingly treated as belonging to the person who it has been gifted to, until in year 7 it is 100% owned by the person who has received it and 0% owned by the person who has made the gift.
Apart from Inheritance Tax what else needs to be considered?
As mentioned above – if there is probably no Inheritance Tax to worry about you might think you can just give as much away as you like. After all, as we get older it’s harder to spend money on things like holidays, and if you see family members struggling you might want to help them.
So, you can do what you like with your assets and money from an Inheritance Tax angle BUT it is not the only consideration. If, as time goes on care is needed, either at home or in a residential home, a local authority will assess your assets when deciding how much you need to contribute towards care costs. If you have given a lot of assets and money away prior to needing care, it can be deemed to be a ‘Deliberate Deprivation of Assets’.
There is a common misconception that the 7-year rule applies in this situation BUT this isn’t true. A local authority won’t care if something was gifted one year ago or twenty years ago. If they think it can be treated as you ‘deliberately depriving yourself’ of assets to avoid care fees, whenever you may have gifted the asset/money, they can try to get the money or asset back from the person/people they were given to.
It’s a bit of a fine line between legitimately giving assets away where there is likely to be Inheritance Tax to worry about (bearing in mind the 7-year rule), and also making sure it wouldn’t be seen as a ‘Deliberate Deprivation of Assets’.
Where there are no Inheritance Tax implications, you can forget about the 7-year rule completely BUT ‘Deliberate Deprivation of Assets’ is still something to consider.
If you’d like any more information about how gifts you are considering making will affect your Inheritance Tax position, please do get in touch.