Gifting money to family: the 7 year rule inheritance tax explained

The 7 year rule inheritance tax explained: this article covers what happens when you give away money or assets during your lifetime, and what it takes for that gift to become fully tax free.

As we all know, the taxman never forgets, except when it comes to gifting, which he thankfully forgets about after seven years, no matter how much you've gifted. It sounds like a complicated area of tax, but the rule itself is simple.

However, misunderstanding it can prove very costly. There is no upper limit on how much can be gifted tax free. Give away £7 million and survive 7 years and a day, and the entire amount falls outside your estate with nothing owed on it at all, yet die just one day earlier, at 6 years and 364 days, and millions would be owed in tax.

What is the 7 year inheritance tax rule?

When you give money or assets away during your lifetime, it's known as a potentially exempt transfer, or PET. The 7 year rule inheritance tax treatment means it sits outside your estate for tax purposes, but only once 7 years have passed.

Until then, the gift takes up your nil rate band, currently £325,000. This is an important part of the 7 year inheritance tax rule. Tax is only due if the gift exceeds whatever's left of that band at the time.

However, survive the full 7 years and the gift becomes fully exempt, no matter how large it was.

Gifting versus not gifting: a £700,000 example

To see how this plays out, take someone with a £700,000 estate deciding whether to gift some of it away now.

Action	Gift amount	Estate left at death	Allowance left for estate	Taxable amount	Tax due (40%)
No gift	£0	£700,000	£325,000	£150,000	£150,000
Gift £100,000	£100,000	£600,000	£225,000	£150,000	£150,000
Gift £325,000	£325,000	£375,000	£0	£150,000	£150,000

If death comes within 7 years

While the gift stays within the £325,000 band, the total tax bill stays fixed at £150,000 regardless of how it is split. However, once the gift goes beyond that band, the picture changes. Taper relief then becomes relevant.

Action	Gift amount	Estate left at death	Allowance left for estate	Taxable amount	Tax due (40%)
No gift	£0	£700,000	£325,000	£375,000	£150,000
Gift £100,000	£100,000	£600,000	£325,000	£275,000	£110,000
Gift £325,000	£325,000	£375,000	£325,000	£50,000	£20,000
Gift £400,000	£400,000	£300,000	£325,000	£0	£0

If death comes after 7 years

Once 7 years pass, the nil rate band resets fully for the estate. As a result, a £400,000 gift wipes out the tax bill entirely

Taper relief under the 7 year inheritance tax rule

Taper relief only applies to the portion of a gift that exceeds the nil rate band, and only if death occurs within 7 years. Take a £400,000 gift. The first £325,000 is covered by the nil rate band.

The remaining £75,000 is taxable. However, the rate falls the longer the donor survives. The rest of the £300,000 estate has no allowance left and is taxed at 40%, a fixed £120,000 regardless of timing.

Time before death	Gift amount	Rate on £75,000 excess	Tax on excess	Tax on £300,000 estate	Total tax due
Within 3 years	£400,000	40%	£30,000	£120,000	£150,000
3-4 years	£400,000	32%	£24,000	£120,000	£144,000
4-5 years	£400,000	24%	£18,000	£120,000	£138,000
5-6 years	£400,000	16%	£12,000	£120,000	£132,000
6-7 years	£400,000	8%	£6,000	£120,000	£126,000
After 7 years	£400,000	0%	£0	£0	£0

The £120,000 owed on the estate itself never changes. In contrast, the 7 year gift rule gradually reduces the tax on the taxable gift.What falls is the tax on the gift, gradually, until the 7 year mark clears it completely.

Getting advice on the 7 year inheritance tax rule

The 7 year rule inheritance tax rules look simple on paper, but the numbers change quickly once a gift crosses the  nil rate band. Speaking to a financial advisor before making significant gifts can avoid costly surprises for the people left behind.