The Inheritance Tax "14 Year Rule"
It is commonly known that when an individual makes an outright gift, provided they survive seven years from the date of making the gift it will generally fall out of their estate for Inheritance Tax (IHT) purposes. This type of gift is called a 'Potentially Exempt Transfer' as it will potentially be exempt from IHT provided the donor lives for more than seven years.
Other types of gift, such as gifts made to discretionary trusts, are 'Chargeable Lifetime Transfers'. This means they are chargeable to IHT at 20% in the donor's lifetime if the total value of such gifts is in excess of the IHT Nil Rate Band of £325,000. There is then a further IHT charge of 20% if the donor dies within seven years. However, in some circumstances the chargeable lifetime transfer may need to be taken into account if death occurs up to 14 years later.
Circumstances in which a gift may take up to 14 years to come out of the estate
If a donor dies within seven years of making a Potentially Exempt Transfer, that transfer (or gift) becomes chargeable. The IHT rules then state that any other chargeable transfers made in the seven years prior to date of the 'failed' potentially exempt transfer must be taken into account to determine how much of the nil rate band has been used up by these gifts. This is best shown in an example:
Frank makes the following gifts:
May 2002 - £250,000 to a discretionary trust (chargeable lifetime transfer)
April 2009 - £150,000 to his daughter (potentially exempt transfer)
Frank then dies in March 2016.
There would have been no IHT payable in Frank's lifetime as the £250,000 chargeble gift to the trust was within the Nil Rate Band (£250,000 for 2002/3) and as the gift to his daughter of £150,000 was a Potentially Exempt Transfer no IHT would have been payable then either.
However, on death the story is different. The gift to his daughter has become chargeable as Frank died within seven years. Any other chargeable transfers in the seven years prior to the failed potentially exempt transfer now need to be taken into account to calculate how much Nil Rate Band is available. As the 2002 gift to trust was less than seven years before the gift to his daughter, it uses up £250,000 of the Nil Rate Band. There is only £75,000 of the £325,000 Nil Rate Band remaining to set against the £150,000 gift to his daughter so £75,000 of this gift is now chargeable to IHT. In this instance, the £250,000 gift to the discretionary trust has resulted in an IHT charge on death nearly 14 years later.
This example shows the importance of the order and timing of gifts. Inheritance tax planning is a complex area and we suggest clients seek personalised financial and legal advice. Note tax rules are subject to change by the government and this article does not constitute personalised financial advice.
Richard Higgs at Wealth West provides important Chartered Financial Planning advice for the retired and elderly in BS9, delivered in a friendly way and on a face to face basis in the comfort of clients' own homes. He specialises in particular in planning for inheritance tax and long-term care as well as investment and retirement planning advice. He can be reached on 0117 966 5699 or firstname.lastname@example.org.