Robert Cartmell explores the relatively unknown “14-yr rule” period which can apply to lifetime gifts instead of the usual 7 years for Inheritance Tax purposes

The reasons why a 14 year rule period might apply to lifetime gifts, by estate planning expert Robert Cartmell.

I, Robert Cartmell, have worked in estate planning work for over 25 years and there have been many instances where people have created trusts during their lifetime (rather than just via Wills) and also made gifts with the hope of such gifts falling outside of their estate for Inheritance Tax purposes.

A 14 year rule?

Making lifetime gifts for Inheritance Tax (IHT) purposes is something many people understand, to some degree.

For families who are likely to have estates that are exposed to IHT on death, making lifetime gifts is an effective and legitimate means of mitigating IHT.  There are rules that govern such arrangements (such as that the donor of the gift cannot ‘reserve an interest’ in the asset or money gifted) but the principle is firmly established as a good part of estate and IHT planning.

You may be familiar with the ‘7 year rule’.  However, gifts in certain circumstances and made within 14 years of death can still attract IHT.

How does the 14 year rule operate?

To understand this, we need first to understand the ‘types’ of gifts for IHT purposes, being:

  1. An Exempt transfer (ExT)

An ExT is a gift that qualifies for an exemption from IHT.  Primarily this includes a gift between spouses and civil partners or gifts to registered UK charities.

  1. A Potentially exempt transfer (PET)

A PET is a gift to a person (not being a spouse or charity).  The 7 year rule relates to PET gifts.  Therefore, provided that the donor retains no benefit in the gifted asset or capital, the value of the gift will fall out of the donor’s estate for IHT purposes on death after 7 years.

If the donor dies within the 7 year period, the value of the gift (called a ‘failed PET’) will add back in to the deceased’s estate, and IHT may be chargeable if the total of that value at death exceed the IHT nil-rate band (NRB), which is still currently £325,000. For larger gifts or series of gifts, taper relief may apply to reduce the IHT payable where the donor survived for at least three years following the PET.

  1. A Chargeable lifetime transfer (CLT)

The third gift ‘type’ is a CLT. Most commonly, a CLT applies for gifts into a Discretionary Trust or other similar (non-exempt) trust vehicle.

There is a 20% IHT charge if the value of the ‘current’ CLT and any CLTs made within the previous seven years of the current CLT exceeds the NRB. The charge is on the excess.  There will be no further IHT to pay, unless the person making the CLT dies within 7 years, although there is potential for taper relief to apply if further IHT is payable in that event.

The 14-year rule

Given those gift ‘types’, things get more complicated in this scenario:  if the deceased made

  • A first gift to a trust (being a CLT, not a PET) more than seven years before their death; and
  • A second gift (a PET) made within seven years of the first gift.

In that event, the earlier CLT may also be caught by the IHT regime, inviting the possibility of IHT being paid on gifts made up to 14 years pre-death

An example

  • year 1: Stephen made a CLT to a trust of £100,000
  • year 5: Stephen made a PET of £300,000 to his son
  • year 9: Stephen dies.

It might initially appear that the CLT of £100,000, having occurred over 7 years pre-death, would be ignored.  Likewise, it might appear that IHT does not arise on the now failed PET, as it is within the £325,000 NRB.

However, this is not so.

In order to calculate the available NRB to offset against the PET, it is necessary to consider events that occurred in the seven years preceding the PET.

So, in the above example, the true position is that although there is no IHT itself on the CLT, it reduces the NRB to £225,000. When calculating the IHT position of the failed PET, the position is as follows:

  • value of PET: £300,000
  • less NRB: (£225,000)
  • Balance £75,000
  • IHT @ 40% x £75,000: £30,000

Therefore, in this case, a CLT made within 14 years of death may not in itself create an IHT liability. However, it erodes the NRB available to offset against a subsequent PET where death occurs within seven years of that PET and 14 years of the initial CLT.

Advice?

If you are considering making a PET and a CLT at or around the same time, it is advisable to make the PET prior to making the CLT.

Likewise, when making a PET, consider any CLTs you have made in the previous 7 years.  You may wish to postpone making the PET until the 7 year period has expired from the initial CLT.