Gifts inter vivos: how to protect clients making gifts from inheritance tax

Lifetime gifts and the seven year rule: when inheritance tax falls on the recipient 

During a person’s lifetime they (‘donor’) can make gifts of unlimited value to other person(s) (‘recipient(s)’). The gifts can be exempt from day one but if they aren’t then the donor needs to survive seven years for the gifts to be fully exempt from IHT. But if the donor doesn’t survive seven years tax might be payable by the recipient. 

Gifts sit in chronological order and use up the deceased’s standard nil-rate band first. Tax is payable if the gift is more than the deceased’s standard nil-rate band (£325,000 but could be higher if the deceased can benefit from a transferable nil-rate band) the person receiving the gift will have to pay IHT.  

To make sure that recipients can pay the IHT liability insurance can be provided. 

As advisers you will probably be conversant with providing insurance cover where one gift has been made, however, for a number of reasons clients may make multiple gifts.  

But for ease let’s first look at an example where a donor has only made one gift of £450,000 and has already used the £3,000 annual exemption. As the value of the gift exceeds their standard nil-rate band by £125,000, IHT will be payable and depending on when the donor dies taper relief will apply. A gift inter vivos policy for the taxation liability on this amount is therefore a suitable solution. So, in this instance a policy starting with £50,000 (40% of £125,000) of cover which then reduces by £10,000 each year after year three would be recommended. In addition to setting up the gift inter vivos policy you should consider what liability remains on the rest of the individual’s estate.

As the nil-rate band has been used up, the beneficiaries of the rest of the estate have an increased liability until the gift falls outside of the estate and the full nil-rate band is available again in seven years. Unless the rest of their estate would be exempt from IHT, for example because it’s all being left to a spouse or civil partner, they should consider covering this liability by means of a level term assurance, as taper relief does not apply to this sum. The cover needed is £130,000 equivalent to the 40% tax liability on the nil-rate band. The policy term for this also needs to be set at seven years.

Now let’s look at a client that makes multiple gifts.  

Case study

In December 2022 Max gave his niece £400,000 for a house purchase. Fast forward to May 2026 and his nephew is now wanting to purchase his first house. Max also wants to help his nephew and decides to gift him £400,000. It’s only when he is talking to a friend that Max realises if he doesn’t survive seven years that his niece and nephew will have tax to pay on these gifts. He decides to seek advice from a professional.  

Max has never married and on his death his estate goes equally to his sister, niece, and nephew. This means that Max is only entitled to the standard nil-rate band (currently, £325,000). 

Whilst the first gift was made 3 ½ years ago if Max dies before December 2029 this gift will fail and use up all of his nil-rate band, leaving his niece with a tax liability of £30,000 (40% x (£400,000 - £325,000). However, as Max has already survived for three years taper relief will be applied to reduce the tax liability.  

If Max survives for seven years then the gift to his niece becomes exempt. 

With Max making a second gift in May 2026 if he dies before December 2029 his nephew will have a tax liability of £160,000 (40% x £400,000) before taper relief, as gifts sit in chronological order with the first gift using up the full nil-rate band. However, if Max died in January 2030 the nil-rate band would be used against the second gift.  

How can Max ensure that his niece and nephew can cover the IHT liability? The first point is that each recipient is liable to the tax on their individual gift. The most common way to cover this liability is to set up either a plan with cover reducing to match the reduced liability (‘gift inter vivos’) or alternatively to set up a series of level plans.

For the first gift Max sets up a series of level protection plans with terms ranging from one to four years (as the gift was made 3 ½ year ago) each having a sum assured of £6,000. After December 2029 Max can decide to cancel the last plan as this would run to May 2030. Each plan can be set up own life in trust for his niece. 

What cover is required for the second gift? 

For the first 3 years his nephew’s liability will be £160,000, but if Max dies between May 2029 and December 2029 with taper relief this would be £128,000. However, once the first gift becomes fully exempt then his liability reduces to £30,000 (ignoring taper relief). Again, Max should consider taking out level plans with terms ranging from four to seven years. But how much should the sum assured be?

The final piece that needs to be considered is that whilst the gifts remain in the calculation for IHT the rest of Max’s estate will have no nil-rate band which means there will be an increased liability on Max’s estate which should be covered by a seven year level term with a sum assured of £130,000 (40% x £325,000). This plan should be set up own life in trust for his estate beneficiaries.