Inheritance tax and the 14-year rule

Gifts made more than seven years before the donor’s death are always free of IHT. However, the impact of the 14-year rule is that certain gifts made more than seven years before death – and which would consequently be outside of the estate – could still affect the amount of tax due on later gifts that were made within the seven-year window.

For advisers, understanding how the 14-year rule works will help clients with the timing and value of gifts to achieve better IHT outcomes. In some cases, it could mean that clients may still wish to cap the amount they gift, or defer gifting until a later date. But in others, there may be scope to safely make larger gifts. 

Here, we explore the details. 

Making lifetime gifts 

Lifetime gifting is a core element of IHT planning. But often when financial planners recommend making gifts, they are not faced with a "clean slate" when it comes to the gifting record. 

When gifting consists of only making chargeable lifetime transfers (CLTs) into discretionary trusts, most clients will want to keep the seven-year cumulative value of CLTs to below the nil-rate band. If they exceed the nil-rate band, there will be an immediate lifetime charge on the excess of 20 per cent.

However, if clients wish to gift more than the nil-rate band, they may consider making direct gifts that qualify as potentially exempt transfers (PETs). 

These will never attract a tax charge during the donor’s lifetime and will be exempt once the donor has survived seven years. If the donor dies within seven years the PET becomes chargeable and this may impact on the amount of IHT that could be payable. But how?

Running the numbers: IHT calculations on death

To answer this, we need to look at how IHT is calculated on death. 

There are two calculations – one for the tax on the estate itself, and the other on "failed" gifts in the last seven years. 

The tax on the estate is broadly the value of the estate, less any available nil-rate band. This includes the residence nil-rate band (RNRB) and any transferable nil-rate band and RNRB from a deceased spouse/civil partner. 

The available nil-rate band will be reduced by all the chargeable transfers, including PETs that become chargeable in the seven years before death. 

Any gifts older than seven years can be ignored. The 14-year rule does not apply here. 

However, it is important to remember that the chargeable transfers do not reduce the residence nil rate band including any transferred RNRB from a deceased spouse.

IHT on lifetime transfers

We also need to look at each lifetime transfer in turn going back the seven years before death.