In this article we look at the key points of lifetime transfers.

In essence, a lifetime transfer is about giving away money from your estate to reduce your inheritance tax bill.

Inheritance tax exemptions can be achieved by means of making certain exempt transfers, which apply in a number of cases, including:

  • Wedding gifts
  • Life insurance premiums
  • Making gifts to your family
  • Gifts to a charity

If appropriate, you can transfer some of your assets while you’re alive, these are known as lifetime transfers.

Whilst we are all free to do this whenever we want it’s important to be aware of the potential implications of such gifts, and in particular with regards to inheritance tax.

The two main types are potentially exempt transfers and chargeable lifetime transfers.

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What is a Potentially Exempt Transfer (PET)?

Potentially exempt transfers are lifetime gifts or other transfers of assets made directly to other individuals (which includes gifts to a bare trust), that may be exempt from inheritance tax, depending on the donor’s survival. These transfers can take many forms, but they all have the potential to reduce the value of an estate for inheritance tax purposes.

However, there are strict rules around potentially exempt transfers, and if the donor dies less that seven years after making the transfer, the asset will be subject to inheritance tax.

Gifts to a spouse or civil partners are fully exempt, so there is no IHT liability. Where a potentially exempt transfer fails to satisfy the conditions to remain exempt, because the person who made the gift died within seven years, it’s value will form part of their estate.

If on the other hand the donor survives for at least seven years full exemptions from inheritance tax apply.

What is a Chargeable Lifetime Transfer (CLT)?

Chargeable lifetime transfers are transfers of assets that are subject to UK inheritance tax. The charge is levied on the value of the assets transferred, and is paid by the person making the transfer.

CLTs can include gifts of money or property, as well as certain types of trusts. Typically, CLTs are made during a person’s lifetime, but they can also be made after death. Any asset that is subject to UK inheritance tax can be a chargeable lifetime transfer, including:

  • houses
  • businesses
  • business assets
  • business property
  • investments
  • life insurance policies

A chargeable lifetime transfer is not conditionally exempt from inheritance tax. For example, if it’s covered by the nil rate band and the donor survives at least seven years, it will not attract a tax liability. But it could still impact on other chargeable transfers.

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The Seven Year Rule

Chargeable lifetime transfers that exceed the available nil rate band when they are made, result in a lifetime inheritance tax liability.

Failure to survive seven years results in the value of the chargeable lifetime transfer being included in the donor’s estate.

If the chargeable lifetime transfers are subject to further inheritance tax on death, a credit is given for any lifetime inheritance tax already paid.

Following a gift to an individual or bare trust, there are two potential outcomes for iht purposes.

1) Survival for seven years or more

This results in the potentially exempt transfer becoming completely exempt and no longer figuring in the inheritance tax assessment.

2) Death preceding seven years

Here, the amount transferred less any inheritance tax exemptions is notionally returned to the estate as if it wasn’t made in the first place.

Let’s Consider The Tax Consequences

Anyone utilizing potentially exempt transfers for tax mitigation purposes therefore should consider the consequences of failing to survive for seven years. Such an assessment will involve balancing the likelihood of surviving for seven years against the tax consequences of death within that period.

Failure to survive for the required seven year period results in the full value of the potential exempt transfers being notionally included within the estate.

Survival beyond then means nothing is included, however taper relief may reduce the inheritance tax liability on the failed PET after the full value has been returned to the estate.

What if earlier transfers have been made?

The value of the potential exempt transfers is never tapered. The recipient of the failed PET is liable for the inheritance tax due on the gift itself, and benefits from any taper relief.

The inheritance tax due on the potential exempt transfers is deducted from the total inheritance tax bill and the estate is liable for the balance.

Lifetime transfers are dealt with in chronological order upon death. Earlier transfers are dealt with in priority to later ones, all of which are considered before the death estate.

If a lifetime transfer is subject to inheritance tax because the nil rate band is not sufficient to cover it, the next step is to determine whether taper relief can reduce the tax bill for the recipient of the potentially exempt transfer.

Sliding Scale and Taper Relief

The amount of inheritance tax payable is not static over the seven years prior to death. Rather it is reduced according to a sliding scale dependent on the passage of time from the giving of the gift to the individual’s death. No relief is available if death is within three years of the transfer itself.

For survival for between three and seven years taper relief at the following rates are available:

How Long Ago Was The Gift MadeAmount of Taper Relief
0-3 yearsNo reduction
3-4 years20%
4-5 years40%
5-6 years60%
6-7 years80%
7 years +No tax to pay

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 bands. The rest of the estate will be charged with the full rate of inheritance tax, usually 40%.

Who Actually Pays The Tax?

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.

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