Transfers Exempt From Inheritance Tax

When contemplating estate planning, it’s pivotal to grasp the nuances of lifetime transfers and the significant impact of the 7-year rule. Gifts made during one’s lifetime are classified either as Potentially Exempt Transfers (PETs) or Chargeable Lifetime Transfers (CLTs), based on the nature of the gift and its recipient, unless the gift fall under an exemption. This distinction is crucial for anyone aiming to navigate the complexities of Inheritance Tax efficiently.

STRATEGIES FOR INHERITANCE TAX EXEMPTIONS

A variety of transfers can be exempt from Inheritance Tax, encompassing wedding gifts, life insurance premiums, familial gifts and donations to charities. These exemptions offer strategic pathways for mitigating potential tax liabilities. Understanding their potential implications on your estate’s Inheritance Tax is essential when executing non-exempt transfers.

PETS VERSUS CLTS

PETs involve direct gifts to individuals or Bare Trusts, potentially exempt from Inheritance Tax if the donor survives for at least seven years post-transfer. On the other hand, similar gifts to discretionary trusts are categorised as CLTs and adhere to a different set of tax rules.

Notably, gifts to a spouse are exempt and, thus, not subject to Inheritance Tax considerations.

CRITICAL ROLE OF THE 7-YEAR RULE

The 7-year rule is a cornerstone in determining the tax status of both PETs and CLTs. For PETs to be exempt from Inheritance Tax, the donor must survive for seven years following the gift. CLTs exceeding the nil rate band at the time of transfer may incur an immediate tax liability, though surviving seven years from the gift date can alleviate further taxes.

TAX IMPLICATIONS OF LIFETIME TRANSFERS

CLTs that surpass the nil rate band threshold at the time of the gift trigger an immediate Inheritance Tax charge. If the donor fails to survive the seven-year period, these transfers must be included in the estate valuation for tax purposes. Individuals must contemplate such transfers’ potential outcomes and tax implications, including the possibility of taper relief on failed PETs.

ASSESSING THE RISK OF NOT SURVIVING SEVEN YEARS

Employing PETs as a strategy for tax mitigation warrants a careful consideration of the risks associated with not surviving the 7-year period versus the potential tax benefits. Failure to meet this condition leads to the inclusion of the full value of the PETs within the estate for tax purposes, albeit with possible adjustments for taper relief.

 TAPER RELIEF 

The rate of Inheritance Tax gradually reduces over the 7-year period – this is called ‘taper relief ’. It works like this:

*How long ago was the gift made?

**How much is the tax reduced?

It’s important to remember that taper relief only applies to the amount of tax the recipient pays on the value of the gift above the nil rate band. The rest of your estate will be charged with the full rate of Inheritance Tax – usually 40%.

PRIORITISING EARLIER LIFETIME TRANSFERS

In the realm of estate planning, understanding the treatment of earlier lifetime transfers is crucial. The valuation of Potentially Exempt Transfers (PETs) remains constant, consuming a portion or the entirety of the nil rate band for the full seven-year period without any tapering. Moreover, the recipient of a PET that fails – due to the donor’s death within seven years – is responsible for the Inheritance Tax on the gift. However, they may benefit from taper relief if the gift’s value surpasses the nil rate band. Importantly, when assessing an estate upon death, lifetime transfers are considered in chronological order, with earlier transfers taking precedence over later ones.

ROLE OF TAPER RELIEF IN REDUCING TAX BILLS

The calculation of Inheritance Tax on gifts exceeding the nil rate band is dynamic, adjusting according to a sliding scale based on the time elapsed from the gift’s date to the donor’s death. No taper relief is applicable if the donor passes away within three years of the transfer. However, for durations between three and seven years, taper relief is available at specified rates, offering a method to potentially reduce the tax liability for the recipient of the gift.

TAX IMPLICATIONS ON LIFETIME TRANSFERS

The taxation of chargeable lifetime transfers bears resemblances yet distinct differences from potentially exempt transfers. When such a transfer occurs, it’s evaluated against the donor’s nil rate band. Should the transfer exceed the nil rate band, the tax incurred is 20% if covered by the recipient or escalates to 25% if the donor assumes the tax responsibility.

The seven-year rule, similar to that for potentially exempt transfers, further complicates this framework. Should the donor not survive this period, Inheritance Tax on chargeable lifetime transfers becomes payable by the recipient. The standard tax rate of 40% applies to amounts above the nil rate band, albeit taper relief may mitigate the financial burden, with credits available for any taxes previously settled during the donor’s lifetime.

ESTATE PLANNING AND THE GIFT OF CAPITAL

The seven-year threshold crucial to both potentially exempt and chargeable lifetime transfers might escalate the Inheritance Tax liability for those who do not outlive this duration subsequent to a capital gift.

In scenarios where Inheritance Tax is levied due to a failed potentially exempt transfer, the financial obligation falls upon the recipient. Conversely, should Inheritance Tax be due following a chargeable lifetime transfer at the time of death, trustees are liable, with any residual tax being a charge against the estate.

STRATEGIC UTILISATION OF TRUSTS

Addressing the potential Inheritance Tax disparity necessitates employing either a level or decreasing term assurance policy structured within a trust tailored for those impacted by the impending Inheritance Tax liability. This strategic placement ensures the policy’s proceeds remain outside the settlor’s taxable estate. The selection between a level or decreasing term assurance and the requisite coverage hinges on specific circumstances. If transfers are confined within the nil rate band, taper relief becomes irrelevant.

Yet, the absence of taper relief does not negate the need for insurance. Demise within the seven-year window leads to the inclusion of the full transfer value within the estate. This inclusion potentially subjects other estate assets to taxation, which could have been circumvented had the donor survived beyond the seven-year mark.

SAFEGUARDING ESTATE LEGATEES

Under these circumstances, a seven-year level term policy emerges as a prudent choice. Establishing a trust benefiting estate legatees is common practice to ensure that any supplementary Inheritance Tax is borne by the estate.

When the combined total of potentially exempt transfers or chargeable lifetime transfers surpasses the nil rate band, it becomes possible to forecast the tapered Inheritance Tax liability ensuing from death post-transfer.

ROLE OF ‘GIFT INTER VIVOS’ POLICIES

To counter the depreciating tax liability that recipients might face, a ‘gift inter vivos’ policy is advisable. Such a policy, anchored in a suitable trust, delivers a lump sum designed to offset potential Inheritance Tax liabilities arising should the donor pass away within seven years of the gift.

Trustees might consider adopting a life of another policy provided insurable interest exists, to address potential liabilities. It’s crucial to note that taper relief solely affects the tax element: the entirety of the gift’s value is incorporated within the estate. Consequently, this action depletes the nil rate band available to the estate’s remainder after seven years.

WHOLE-OF-LIFE COVER

Therefore, the estate itself will also be liable to additional Inheritance Tax on death within seven years, and depending on the circumstances, a separate level term policy written in an appropriate trust for the estate legatees might also be required.

Where an Inheritance Tax liability continues after any potentially exempt transfers or chargeable lifetime transfers have dropped out of the account, the whole- of-life cover written in an appropriate trust should also be considered.

Need Help With Inheritance Tax?

Book a Free Initial Consultation With Us.

BOOK NOW

Capital at risk.