Gifting money to your family: the 7-year rule and what most people get wrong

Giving money away during your lifetime can reduce the inheritance tax your estate owes when you die. The principle is simple: assets that have left your estate cannot be taxed as part of it.

But the rules around gifting are more detailed than many people realise, and the mistakes tend to be discovered only after death, when nothing can be done to fix them.

How the seven-year rule works

If you make a gift and survive for seven years after making it, that gift is outside your estate for inheritance tax purposes. These are called potentially exempt transfers.

If you die within seven years of making a gift, it may still be taxed, depending on its size. Gifts made in the last three years before death are taxed at the full 40% rate. Gifts made between three and seven years before death benefit from taper relief, which reduces the rate.

• 3-4 years before death: 32% tax rate
• 4-5 years before death: 24% tax rate
• 5-6 years before death: 16% tax rate
• 6-7 years before death: 8% tax rate
• More than 7 years before death: 0% tax rate

Taper relief only applies to the amount of the gift that exceeds the nil-rate band. For most people, the nil-rate band will be used up by their estate first, so taper relief may not reduce the tax as much as it initially appears.

Annual exemptions you can use immediately

Certain gifts are immediately outside your estate, without any seven-year wait. These are the most accessible and underused planning tools.

• Annual exemption: £3,000 per year, per person giving. Unused allowance can be carried forward one year only.
• Small gifts: up to £250 per person per year, to any number of people, provided no other exemption has been used for that same person
• Wedding gifts: £5,000 to a child, £2,500 to a grandchild, £1,000 to anyone else, given on or shortly before the wedding
• Regular gifts from surplus income: immediately exempt if they are genuinely out of income, regular, and do not reduce your standard of living

The normal expenditure from income exemption

This exemption is one of the most valuable and least understood. If you have regular income above what you need to live on, you can gift the surplus to family members and those gifts are immediately outside your estate.

The gifts must be regular, come from income rather than capital, and must not affect your normal standard of living. If you can demonstrate a pattern of regular payments, this can be a powerful tool over time.

Common mistakes

• Not recording gifts with dates and amounts
• Gifting a home but continuing to live there without paying rent
• Assuming taper relief wipes out the tax entirely
• Confusing the annual exemption amount with the nil-rate band
• Forgetting that annual exemptions cannot be carried forward more than one year

The importance of timing

The earlier you start gifting, the more of your estate you can move outside the inheritance tax net. A gift made today starts the seven-year clock immediately. A gift made in ten years will not.

Devonshire Wealth connects families with inheritance tax specialists who can help you build a gifting strategy that fits your circumstances. Visit our inheritance tax planning page to find a qualified adviser.