Inheritance Tax insurance and the 7-year rule

Currently, the number of people being charged Inheritance Tax (IHT) on gifts is growing rapidly. A major part of the problem is estates falling foul of the ‘7-year rule’. This allows you to make gifts that are free of Inheritance Tax, provided you live at least seven years afterwards. Unfortunately, the COVID-19 pandemic reminded us that life is uncertain. As a result, some people are taking a relatively novel approach to tax planning – by taking out Inheritance Tax Insurance.

The 7-year rule

It’s worth providing a quick recap on the 7-year rule.

Put simply, if you want to make a gift that isn’t exempt from Inheritance Tax, you can take advantage of the 7-year rule. If you live for more than seven years after making the gift, then no IHT is payable.

Unfortunately, if you don’t live for the full seven years, the gift becomes subject to a sliding scale of IHT. Let’s assume you gift one of your children £100,000. These are the amounts of IHT that would be payable if you died after the following number of years:

• 0-3 years: 40% / £40,000 (i.e. the standard rate of IHT)
• 3-4 years: 32% / £32,000
• 4-5 years: 24% / £24,000
• 5-6 years: 16% / £16,000
• 6-7 years: 8% / £8,000
• 7+ years: 0% / £0

Our article What are the IHT rules on gifts? gives you a more detailed insight into the topic. However, as you can see, the earlier you plan and make your gift, the less likely it is to attract Inheritance Tax.

Inheritance Tax insurance

According to an article in the Daily Telegraph, there is a growing interest in Inheritance Tax insurance. These gift insurance policies – also known as ‘gift inter vivos’ plans – will pay out if the person who has made the gift dies within seven years.

The policies don’t alter the fact that IHT becomes due. Instead they pay out a lump sum to meet the Inheritance Tax bill.

The Telegraph gives an example of a 70-year old who gifts £2.5m. If they die within three years, then £1m Inheritance Tax becomes due on the gift. (This assumes the £325,000 IHT allowance has been used up).

However, if they have a ‘gift inter vivos’ policy, the insurance payout would cover the IHT bill.

There is a catch, of course. The older you are, the more expensive the premiums will be. In the case of the 70-year-old, the premium would have been over £6,000 in the first year. If they were 80 years old, the amount would rocket to somewhere in the region of £28,000.

Inheritance tax insurance and trusts

If you were to take out IHT gift insurance, you need to place it in a trust. This ensures that any payout is not considered part of the estate. For this reason alone, it’s important to get expert advice before taking out any policy – especially given the new rules about registering trusts.

Is IHT insurance worth it?

In an ideal world, you’d plan for IHT as early as possible and make gifts at the youngest age you can. By doing so, you’re much less likely to fall foul of the 7-year rule. That said, if you are gifting very large amounts of money want the security of knowing a family member won’t be hit by a huge Inheritance Tax bill, this kind of insurance could give you peace of mind. For more advice, talk to us about Inheritance Tax planning. Our service is tailored to your individual circumstances and is designed to help you plan for your future and that of your loved ones.