IHT planning: protecting against the seven-year rule

16 May, 2022

Protection Taxation and trust

Gift inter vivos can protect dependants against a potential inheritance tax liability if your client dies within seven years of making a gift.

A sinister phenomenon known as ‘fiscal drag’ is pulling more people into the taxman’s clutches – and this is particularly true for inheritance tax (IHT), one of the UK’s most penal taxes.

The IHT nil rate band has remained at £325,000 since 2009, with estates worth more than that facing a 40% tax charge, and the current government has no intention of increasing it until 2026 at the earliest.

One way that clients can mitigate an IHT liability, of course, is to gift assets during their lifetime. Certain financial gifts leave an estate immediately. However, as advisers will know, the sums are relatively small. Tax-free gifts of £3,000 a year; wedding gifts of up to £5,000 to a child depending on who’s making the gift; and £250 per person to an unlimited number of people.

Larger gifts can make a substantial difference – not only to the lives of recipient beneficiaries while the donor is around to see how their money has helped, but also to a potential IHT liability. The so-called bank of grandparents or mum and dad are increasingly giving first-time buyers large deposits to help them get on the housing ladder and some buy-to-let landlords are giving away properties to family members. This comes with one major proviso – that the person making the gift lives for at least three years and ideally at least seven. If not, then at best, the value of the gift uses up some or all of their nil rate band and at worst, any excess is taxed at 40% on the recipient!

Those who want to plan for all eventualities are increasingly protecting this liability with ‘gift inter vivos’.

What is gift inter vivos?

A gift inter vivos policy covers any potential IHT liability that their beneficiaries could face if they died within three to seven years of making a gift. It typically entails taking out five single life level term policies that would run for three, four, five, six and seven years respectively, with each covering one-fifth of the potential IHT due on the gift to match the decreasing liability.

Available on large gifts in excess of the nil rate band, taper relief reduces the IHT payable from 40% in years one to three to 8% in year seven, as per the table below:

Years between gift and death	Taper relief applied to tax due	Effective tax rate
Less than 3	0%	40%
3-4	20%	32%
4-5	40%	24%
5-6	60%	16%
6-7	80%	8%
7+	100%	0%

Year / Term	IHT rate	IHT liability	Sum Assured
Year / Term
1-3	40%	£70,000	£14,000
4	32%	£56,000	£14,000
5	24%	£42,000	£14,000
6	16%	£28,000	£14,000
7	8%	£14,000	£14,000

If they both survive the full seven years, their financial adviser will explore whether they still need the remaining joint life second death term policy.

Find out more about Zurich’s recently extended joint life second death term cover on our advised personal protection product.