UK Families Face Rising Inheritance Tax on Gifts Due to Complex Rules

The number of UK families facing inheritance tax on substantial gifts has seen a marked increase, primarily due to the complex seven-year rule. This regulation, which considers assets transferred within seven years of a person's death as part of their estate for tax purposes, is catching many off guard.

According to official figures obtained through a Freedom of Information request, 1,300 families were required to pay death duties on cash or property received from deceased loved ones in the 2020-21 tax year. This represents a significant rise from 590 families in 2011-12, more than doubling over a decade.

Ian Dyall of Evelyn Partners, who acquired the data, noted:

"These figures show that a growing number of recipients will have had a potentially unexpected inheritance tax bill to pay when the donor dies, on a gift that they could have received several years ago. How many had the liquid assets available to pay it? How many had invested the money in illiquid assets like a new home?"

The increase in affected families can be attributed to several factors. The inheritance tax threshold, known as the nil-rate band, has been frozen at £325,000 since 2009 and will remain so until 2028. This stagnation, combined with rising asset prices, has pushed more estates over the tax-free limit.

Families are increasingly giving substantial gifts to help younger generations onto the property ladder or to reduce their estate's value below the threshold. However, many are unaware of or misunderstand the seven-year rule's implications.

The complexity of the UK's inheritance tax system is well-documented. Introduced in 1894 as "estate duty," it has evolved into one of the world's most intricate tax structures. Despite its complexity, only about 4% of estates in the UK are liable for inheritance tax, which currently stands at a 40% rate set in 1988.

As concerns about potential tax changes grow, wealthy savers are taking preemptive action. James Ward of law firm Kingsley Napley reported:

"Several dozen clients have been in touch about concerns regarding an increase to inheritance tax and inheritance tax on pensions. Those with assets between £2m to £5m are particularly worried that the rate of inheritance tax may increase or they may lose their exemptions, like the nil rate band or residence nil rate band."

With speculation about Labour potentially raising inheritance tax to address public finance issues, many are considering making gifts before any changes occur. However, this strategy could backfire if donors don't survive the seven-year period required for the gifts to become tax-free.

It's worth noting that certain gifts are exempt from inheritance tax, including those to spouses, civil partners, and charities. Additionally, annual gifts up to £3,000 are not subject to the tax.

As the debate around inheritance tax continues, families are advised to seek professional guidance to navigate the complex rules and plan effectively for their financial futures.