Does the seven-year rule apply to gifts made to trusts?

Yes. Trusts are also limited by the seven-year rule. While they can help lower IHT costs, they typically don’t eliminate them altogether. If you’re considering putting assets into a trust, it’s vital to get professional advice. Trusts are complicated, and IHT tax rules vary depending on the type of trust you set up.

Can I give away my house but still live in it?

Yes. However, if you transfer ownership to your home and still live in it without paying rent (or paying rent below the market rate), it is classed as a ‘gift with reservation of benefit’. These types of gifts are included within your estate, meaning IHT may be due.

Inheritance Tax (IHT) explained: rules, rates, and reliefs

Recent government statistics show that fewer than 5% of estates are liable for Inheritance Tax (IHT). But, as assets increase in value and tax-free thresholds remain static, it’s a crucial factor to consider as part of your estate planning.

What is the current Inheritance Tax threshold?

Inheritance Tax is paid to the government on someone’s estate when they pass away. Their estate is the assets they leave behind – such as their house, possessions, money, and pensions.

If the total value of their estate is below a certain level (known as the nil-rate band), there is no IHT to pay. The current nil rate band is £325,000.

Anything above this amount can be taxed at the standard IHT rate of 40%. Here’s an example:

Your estate is worth £600,000

The tax-free threshold is £325,000

Your estate will pay Inheritance Tax on £275,000

In this example, your estate would have to pay £110,000 in IHT (40% of £275,000). You can find a detailed guide to IHT calculations at GOV.UK, how Inheritance Tax works.

What happens if I leave everything to a family member?

There may not be any IHT to pay on anything over £325,000 if you leave the total estate to:

Your spouse
Your civil partner
A charity
A community amateur sports club

What happens if I leave my home to a family member?

If you decide to leave your home to your spouse or civil partner, there will be no IHT to pay.

If you decide to leave your home to your children, step-children or grandchildren, you can benefit from extra tax relief, known as the residence nil rate band, which is £175,000. This means the total tax-free allowance increases to £500,000. The residence nil rate band also applies to proceeds from the sale of the home.

Can tax-free allowances be passed on to a spouse or civil partner?

Yes. If one spouse or civil partner passes away, any unused tax relief can be passed on to the surviving spouse or civil partner. When the second person dies, they can pass on the combined allowance to their children or grandchildren. This could mean beneficiaries are left up to £1 million tax-free.

Here’s a working example:

Sam is married to Sue, and they have two children, Jenny and John.

Sam passes away, leaving everything to Sue. This means there is no IHT to pay.

When Sue passes away, she leaves everything to Jenny and John, including:

Sam’s £325,000 tax-free allowance and his residence nil band allowance of £175,000.

Sue’s £325,000 tax-free allowance and her residence nil rate band of £175,000.

This means the total allowance that can be passed on is £1 million.

If the value of the whole estate is less than £1 million, then Jenny and John will not have to pay IHT.

The £2 million exception

The residence nil rate band allowance is reduced for estates worth more than £2 million (even if the home is left to children or grandchildren). So, for every £2 over the £2 million limit, the allowance is reduced by £1. You can find more information at GOV.UK, applying the residence nil rate band.

Understanding the seven-year rule

You can give gifts up to the value of £3,000 every year (your ‘gift allowance’) without the value being added to your estate. This allowance is exempt from IHT.

You also have a ‘small gift allowance’ which lets you make gifts of up to £250 per person each tax year. You can give as many small gifts as you want each year (for example, for birthdays or celebrations).

You can make gifts outside of your gift allowances, but there may be IHT to pay depending on:

when the gift was given;

the value of the gift;

who the gift is for, or from.

Typically, there is no IHT to pay if you live for at least seven years after giving the gift. If you pass away within seven years of giving the gift, IHT may be due.

If IHT is owed, the amount of tax due depends on the time between giving the gift and death:

If the gift is made within three years of your death, it is subject to a 40% tax.

If the gift is made between three and seven years before your death, the tax is calculated on a sliding scale. This is known as ‘taper relief’ (you can find more information at Money Helper):

The value of investments and any income from them can go down as well as up and you might not get back the original amount invested. The past is not a guide to the future. The value of tax benefits depends on your individual circumstances. Tax laws can change.

Years between gift and death	Percentage of tax to be paid
3-4 years	32%
4-5 years	24%
5-6 years	16%
6-7 years	8%
7 years +	0%

If you’re worried about the seven-year rule and owing IHT, you could consider a term life insurance policy to cover that period. A policy set up in trust could then be used to cover any IHT.

What is a potentially exempt transfer (PET)?

This is a term that describes unlimited gift amounts at the time they are given.

If you give the gift and then live for at least seven years, it will also be exempt from IHT.

If you pass away within seven years of making the gift, the PET will be added to the value of your estate. This could mean IHT will need to be paid.

Do you pay IHT on your parent’s house?

This will depend on the total value of your parents’ estate. If their total estate is less than the nil rate band (£325,000), no IHT will be due. For example, if their home and assets were worth a combined £320,000, you would not have to pay IHT.

If your parent leaves their house to you (their child, step-child, or grandchild), you benefit from the residence nil rate band, an extra £175,000 on top of the standard £325,000 nil rate band. You pay inheritance tax only on anything over the combined allowance of £500,000.

Remember that married couples and civil partners can transfer their allowance to their spouses. If the remaining parent leaves assets to you, you could benefit from a tax-free allowance of up to £1 million.

Estates valued over £2 million will be affected by the reduction in tax-free allowance. You can find detailed and technical guidance at GOV.UK, work out and pay the residence nil rate band for IHT.

How can I legally reduce Inheritance Tax?

Few of us want our beneficiaries to pay hefty tax bills on the assets we leave behind, but you can help lower what’s owed by:

Spending or gifting money

Whether you choose to go on several holidays a year, dine out regularly, or indulge in beauty treatments, spending what you have is one of the simplest ways to minimise what’s left and reduce any IHT. Don’t forget you also have gift allowances, so you can treat family members too.

Gifting money to charity is also IHT-free because the amount you give is taken off the value of your estate before IHT is calculated. Giving to charity can reduce IHT overall. If your gift to charity is worth at least 10% of your total estate, the amount of tax to be paid on the remaining estate falls from 40% to 36%.

Investing in assets that qualify for relief

You can claim Business Relief (BR) if you invest in certain business assets. If these assets are held for at least two years, they will be fully or partially exempt from IHT, depending on the type of asset and the value.

More information is available at GOV.UK, Business Relief for Inheritance Tax

Setting up a whole-of-life insurance policy

Whole-of-life insurance policies pay out on death, giving your beneficiaries a tax-free lump sum that can be used to cover IHT costs. However, the policy must be written ‘in trust’ so that it is not counted as part of your estate. Doing this also means it will not be included in probate.

Who is exempt from IHT?

No IHT is due if the value of your estate is below £325,000. You can also avoid IHT if you leave anything over £325,000 to your spouse, civil partner, a charity, or a community amateur sports club. Plus, don’t forget that if your gift to charity is worth at least 10% of your total estate, any IHT on the remaining estate will be charged at 36%, not 40%.

FAQs

Planning for the future, now

IHT is a complex area, but careful retirement planning can help ensure wealth is passed on to the people you want to benefit, while also helping mitigate tax liabilities.

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Inheritance Tax (IHT) explained: rules, rates, and reliefs

In this article

In this article

What is the current Inheritance Tax threshold?

What happens if I leave everything to a family member?

What happens if I leave my home to a family member?