The tax treatment of chargeable lifetime transfers has some similarities to potentially exempt transfers, but with a number of differences.
When a chargeable lifetime transfer is made it is assessed against the donor’s nil rate band.
If there is an excess above the nil rate band it is taxed at 20% if the recipient pays the tax or 25%, if the donor pays the tax.
The same seven year rule that applies to potentially exempt transfers then applies. Failure to survive the end of this period results in inheritance tax becoming due on the charge lifetime transfers, payable by the recipient. The tax rate is usually 40%.
The seven year rules that apply to potentially exempt transfers and chargeable lifetime transfers could increase the inheritance tax bill for those who fail to survive for long enough after making a gift of capital.
If inheritance tax is due in respect of failed potentially exempt transfers, it is payable by the recipient.
If inheritance tax is due in respect of the chargeable lifetime transfer in death, it is payable by the trustees.
Any remaining inheritance tax is payable by the estate.
What About An Appropriate Trust Or Life Insurance Policy?
The inheritance tax difference can be calculated and covered by a level or decreasing term insurance policy, written in an appropriate trust, for the benefit of whoever will be affected by the inheritance tax liability, and in order to keep the proceeds out of the settlor’s estate.
Which is more suitable, and the level of cover required, will depend very much on the circumstances.
If the potentially exempt transfers or chargeable lifetime transfers are within the nil rate band, taper relief will not apply. However, this does not mean that no cover is required.
Death within seven years will result in the full value of the transfer being included in the estate. The knock-on effect is the other estate assets, up to the value of the potential exempt transfers are charged with lifetime transfers, could suffer tax that they would have avoided had the donor survived for the seven years.
As a result, a seven year level term policy could be the most appropriate type of policy in this situation. Any additional inheritance tax is payable by the estate, so a trust for the benefit of the estate legatees will normally be required.
You can also consider a special form of Gift Inter Vivos, which is a life insurance policy that provides a lump sum to cover the potential inheritance tax liability that could arise if the donor of a gift dies within seven years of making that gift.
Where an inheritance tax liability continues after any potential exempt transfers or chargeable lifetime transfers have dropped out of the account whole of life cover written in trust should be considered for the remainder of the liability.