Thinking about what will happen to your money after you pass away can be daunting, but it’s important to plan ahead so that your loved ones are looked after when you’re no longer around. Understanding key concepts such as how taper relief on inheritance tax works, and how it fits into your estate planning, can ensure a smoother transition of your assets and reduce the amount of tax owed by your family.
What is Inheritance Tax?
When you die, your loved ones will generally be liable for a 40% inheritance tax (IHT) rate on any gifts such as money, assets or property you leave to them. The amount of inheritance tax the beneficiary pays is calculated based on the value of the donor’s estate and the inheritance tax is then paid from the deceased’s estate.
Individuals can pass on up to £325,000 free from inheritance tax, referred to as a nil-rate band. If assets in the estate are worth more than the nil-rate bands, they will be liable for inheritance tax. Additionally, you will not be liable for inheritance tax on gifts given to you by your spouse during their lifetime or on their death, as long as you are a permanent UK resident legally married or partnered with that person.
A further £175,000 per person may also be available if a residential property is owned and lived in, referred to as the residence nil-rate band. If you are married or in a civil partnership and one of you dies, you will inherit your partner’s nil-rate band with no IHT liability, meaning you will have a nil-rate band of up to £1,000,000 if including a residential property valued at £350,000 or more.
What is Taper Relief?
There are some cases in which inheritance tax can be reduced. Many people choose to give away their assets before their death to reduce the amount the beneficiary will owe in inheritance tax. These gifts are known as “potentially exempt transfers” (PETs). As long as the donor doesn’t pass away within seven years of making their gift, the gift will be exempt from tax. This is known as the seven-year rule.
However, if the donor passes away within those seven years, inheritance tax may be due at up to a rate of 40%, depending on how much time has passed between the transfer of the gifts and the passing of the donor. Should the donor pass away within 3 years of gifting their assets, IHT must be paid in full. Gifts given three to seven years before the donor’s death are taxed using a sliding scale known as taper relief.
Put simply, taper relief:
- Reduces the tax owed if the donor survives three years after the gift was made
- Operates on a sliding scale from years three to seven, with the tax amount reducing as time passes
- Only applies to the value of gifts over the nil-rate band amount (£325,000 or in some joint cases £650,000)
How Taper Relief Works
The amount of tax the beneficiary owes on their gift depends on when exactly the donor passes away. Starting three years after the gift is made, the rate of inheritance tax reduces (tapers) by 8% each year, until no more tax is due. Taper relief reduces tax on PETs, but not on the estate as a whole. It is also important to note that only the tax amount reduces over the seven-year period, not the value of the gift.
| Years between gift and death | Rate of tax on the gift |
| 0 to 3 years | 40% |
| 3 to 4 years | 32% |
| 4 to 5 years | 24% |
| 5 to 6 years | 16% |
| 6 to 7 years | 8% |
| 7 or more | 0% |
Source: https://www.gov.uk/inheritance-tax/gifts
If you’re unsure whether taper relief applies to gifts you’ve given to your loved ones, get in touch with our expert Wealth Management team today.
Taper Relief Example
Ethel is a widower. She gifts her son Freddie £500,000 in April 2017 having already used her annual allowance elsewhere but sadly passes away in July 2021, just over four years after gifting Freddie the money. The gift was made within seven years of Ethel’s death, meaning this “potentially exempt transfer” (PET) could be subject to inheritance tax.
Taper relief may apply since the time elapsed between the gift and Ethel’s death is over three years. The nil-rate band at the time of Ethel’s death is £325,000, which is deducted from the total value of the gift before the IHT is calculated. After applying the nil-rate band, the taxable amount of the gift is £175,000 (£500,000 minus £325,000).
The standard IHT rate is 40%. Without taper relief, the inheritance tax owed would be £70,000 (40% of £175,000). However, because Ethel passed away four years and three months after making the gift, taper relief reduces the amount of IHT Freddie owes. The rate of tax owed on the gift amount is 24% (40% rate with 60% taper relief), meaning Freddie will have to pay £42,000 (24% of £175,000) instead of the £70,000 he would have owed without taper relief.
Important Considerations
The Nil-Rate Band
It’s important to remember that taper relief only applies to total accumulated gifts above the nil-rate band of £325,000. If the total of all gifts made are below this amount then they are not liable for inheritance tax, meaning taper relief and the seven-year rule do not apply.
Capital Gains Tax
Although some gifts are exempt from inheritance tax, the beneficiary may be faced with capital gains tax if they subsequently sell or dispose of chargeable capital assets. For example, if they inherit property and sell it for more than it was originally worth.
Keeping a Record
It’s recommended that you keep a record when giving money or assets away to loved ones during your lifetime. Make sure to keep a note of:
- What the gift was
- Who it was gifted to
- When it was gifted
- The amount that was gifted
Keep track of each gift in chronological order, as any gifts that use up your nil-rate band may be fully taxable.
Strategic Use in Estate Planning
By gifting to your loved ones while you’re still alive, they may be able to utilise taper relief, saving them a significant amount on inheritance tax.
Getting professional advice from our Wealth Management team will ensure you’re making the most sensible decision when it comes to estate planning. Our team of experts will advise you on how to incorporate tax relief into your estate, helping you calculate potential tax savings and optimise gift strategies so that your loved ones can cope after you pass away.
The value of an investment with St. James’s Place may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation and reliefs from taxation can change at any time and are dependent on individual circumstances.
