How a gift made years ago can still affect your Inheritance Tax bill

Most people know the headline rule: give money away and survive seven years, and the gift falls outside your estate for Inheritance Tax (IHT). What is less well known is that a gift you have long forgotten about can still change the tax payable on a later gift. This is sometimes called the “14-year rule”. In this article we explain where it comes from and why timing matters.

First, what is the nil-rate band?

The nil-rate band (NRB) is the amount you can give away, through lifetime gifts and on death combined, before Inheritance Tax is due. It is currently £325,000 per person. Anything above it is taxed at 40% on death (or 20% on a lifetime gift into a trust, as explained below).

The allowance is used up by chargeable gifts in date order, and a gift stops counting once it is more than seven years old. That is why the timing of gifts, and how long you survive them, can make such a difference.

The basics: PETs and CLTs

Two types of lifetime gift matter here.

• Potentially exempt transfers (PETs) are outright gifts to individuals. They are free of IHT if you survive seven years from the date of the gift. If you die within seven years, the gift “fails” and becomes chargeable.
• Chargeable lifetime transfers (CLTs) are typically gifts into discretionary trusts. They count towards your nil-rate band straight away. Any amount above the nil-rate band is charged at 20% when the gift is made, and if you die within seven years of making it, the tax is recalculated at the death rate of 40%.

Throughout this article we assume a nil-rate band of £325,000 and a death rate of 40%.

A quick note on taper relief: helpful but limited

Where tax is due on a failed gift, taper relief reduces it if you survive at least three years after making that gift:

Taper relief reduces the tax, not the value of the gift, and it only matters where the gift exceeds the available nil-rate band. A gift fully covered by the nil-rate band has no tax to reduce.

Where the “14 years” comes from

There is no single 14-year test. The rule is really two seven-year look-backs that can overlap:

1. A gift only suffers tax if you die within seven years of making it.
2. To work out how much nil-rate band is available to that gift, we then look back a further seven years from the date of the gift and add up any chargeable transfers made in that window.

Put together, a gift made up to 14 years before death can still matter. It may be too old to be taxed itself, but it can use up allowance that a later gift would otherwise have had.

A point that is easy to miss: a PET is only counted in that look-back if it has failed. Which brings us to the importance of the date of death.

A worked example

Consider someone who makes the following gifts:

When the June 2019 trust gift is made, it is covered by the full £325,000 nil-rate band, so no lifetime tax is paid. The PETs in 2022 and 2023 are potentially exempt, so no tax arises on them either.

When the second trust gift is made in October 2026, we look back seven years to October 2019. The 2019 trust gift sits just outside that window (7 years 4 months earlier), and the PETs have not failed, so they are ignored. The full nil-rate band is available again and no lifetime tax is paid.

The outcome on death depends heavily on when it occurs. We compare two dates.

Scenario A: death in January 2027

The 2019 trust gift was made 7 years 7 months before death, so it falls outside the seven-year period. It attracts no tax itself and does not reduce the estate’s nil-rate band. But it still matters, because it sits within the look-back of both PETs.

• PET1 (June 2022) was made 4 years 7 months before death, so it fails. Looking back seven years from June 2022, the 2019 trust gift has already used the whole £325,000 nil-rate band. Tax is £44,000 (40% of £110,000), reduced by 40% taper relief to £26,400.
• PET2 (June 2023) was made 3 years 7 months before death, so it also fails. Its look-back catches both the trust gift and PET1 (£435,000), so again no nil-rate band remains. Tax is £44,000, reduced by 20% taper relief to £35,200.
• The 2026 trust gift is recalculated. Its look-back runs from October 2019, so the 2019 trust gift drops out but the two failed PETs are caught (£220,000), leaving £105,000 of nil-rate band. The taxable amount is £220,000, and tax at 40% is £88,000. Death came only three months later, so no taper relief applies.

The total additional tax on the lifetime gifts is £149,600.

Scenario B: death in July 2031

The 2019 trust gift is now over 12 years old and has no effect. PET1 has survived over nine years and PET2 over eight, so both are fully exempt and drop out of the calculation.

• With no failed PETs in the look-back, the 2026 trust gift is recalculated against the full £325,000 nil-rate band.
• The taxable amount is nil, so the additional tax is £0.

The gifts and amounts are identical. The only difference is how long the donor survived.

Notice too that the 2019 trust gift, made over seven years before death in Scenario A, adds £61,600 to the bill: without it, both PETs would have been covered by the nil-rate band. This is the 14-year rule in action.

What about the estate itself?

The estate is dealt with separately. Its nil-rate band is reduced by chargeable transfers made in the seven years before death. In Scenario A that period starts in January 2020, so the 2019 trust gift is outside it, but the two failed PETs and the 2026 trust gift (£545,000 in total) are all inside, and no nil-rate band remains for the estate. In Scenario B only the 2026 trust gift falls inside, but that alone uses the full £325,000, so again none remains. In both cases the estate is taxed at 40% from the first pound, in addition to the tax on lifetime gifts described above.

Key planning points

We will always consider and discuss gifting rules with clients as part of our ongoing planning. Some of the key planning points to note though are:

• Keep a full gifting record. Dates and amounts of every gift, including those made many years ago, are needed to work out what allowance is really available.
• Think about sequence and spacing. Making a large trust gift while earlier PETs are still within their seven years leaves less allowance for it if death occurs early.
• Review before a large gift. Taking advice first lets you see how much allowance remains and how a short survival period would affect the outcome.
• Consider protection. Life cover policies designed specifically to cover the IHT on gifts can be used to fund a tax liability that arises only if death occurs within seven years.
• Use exemptions first. Annual exemptions, small gifts, and gifts out of normal expenditure from income can fall outside these rules altogether.

Important points to note

The figures above are illustrative. They focus on lifetime gifts only, assume a constant nil-rate band of £325,000, ignore the residence nil-rate band, and do not consider the size of the wider estate. Trusts may also be subject to periodic and exit charges that are not covered here. Tax rules and allowances can change, and their treatment depends on individual circumstances.

This article is for general information only and is not personal advice.

If you would like to review your own gifting history or discuss how these rules could apply to you, please get in touch.