Gifts and Inheritance Tax Planning: The 7-Year Rule and Annual Exemptions Explained

Inheritance Tax (IHT) is charged at 40% on estates above the nil-rate band (£325,000 in 2025-26, or up to £500,000 with the residence nil-rate band). One of the most widely used and legitimate ways to reduce an IHT bill is to give assets away during your lifetime. But not all gifts immediately escape IHT — the rules are nuanced, and understanding them is essential for effective planning.

The nil-rate band and residence nil-rate band

Before discussing gifts, it helps to know the thresholds:

• Nil-rate band: £325,000 — the first £325,000 of your estate is free of IHT.
• Residence nil-rate band (RNRB): An additional £175,000 if you leave your main home to direct descendants (children, grandchildren). This brings the effective threshold for homeowners leaving property to children to £500,000.
• Married couples and civil partners can transfer unused allowance to a surviving spouse, giving a combined potential threshold of £1,000,000.

The RNRB tapers away for estates above £2 million at £1 for every £2 over the threshold.

Gifts that are immediately exempt from IHT

Certain gifts are exempt from IHT regardless of when they are made:

• Annual exemption: You can give away up to £3,000 per tax year free of IHT. If unused, one year's exemption can be carried forward — so you could give £6,000 in a year if you made no gifts the previous year. This exemption is per donor, not per recipient.
• Small gifts: Up to £250 to any number of individuals per tax year, provided the recipient does not receive any other exempt gift from you that year.
• Wedding gifts: £5,000 to a child, £2,500 to a grandchild or remoter descendant, £1,000 to any other person — made on or shortly before the wedding.
• Normal expenditure out of income: Gifts made out of surplus income (not capital) that form part of a regular pattern of giving are exempt. You must be able to demonstrate that, after the gifts, you maintain your normal standard of living from remaining income.
• Gifts between spouses/civil partners: Unlimited gifts between UK-domiciled spouses are completely exempt from IHT.
• Gifts to charities: Fully exempt. Leaving 10% or more of your net estate to charity also reduces the IHT rate on the rest from 40% to 36%.

Potentially Exempt Transfers (PETs) and the 7-year rule

Any gift that is not covered by an exemption is a Potentially Exempt Transfer (PET). A PET becomes fully exempt from IHT if the donor survives for seven years after making it. If the donor dies within seven years, the gift may be brought back into the estate and taxed — though taper relief reduces the rate if the donor survives at least three years.

Taper relief applies to the rate of tax, not to the value of the gift itself. It also only applies once the cumulative value of PETs in the seven years before death exceeds the nil-rate band.

Chargeable lifetime transfers

Gifts to certain trusts (primarily discretionary trusts) are Chargeable Lifetime Transfers (CLTs) rather than PETs. CLTs are taxed at 20% at the time of the gift if they exceed the nil-rate band. If the donor dies within seven years, the rate rises to 40% less any 20% already paid. CLTs are more complex and require specialist advice.

Practical gifting strategies

• Start gifting early: the 7-year clock starts on each gift, so gifting at 60 rather than 75 means far more gifts can clear the 7-year period.
• Use the annual £3,000 exemption every year — it is use-it-or-lose-it (one year carry-forward only).
• Consider gifts out of income for those with significant pension, rental, or investment income that exceeds living costs.
• Keep records of all gifts: amounts, dates, recipients. Executors will need this information to calculate the IHT liability on death.

Frequently asked questions

If I give my house to my children, is it immediately outside my estate?

Not necessarily. If you give your home to your children but continue to live in it rent-free, HMRC treats it as a "gift with reservation of benefit" and keeps it in your estate as if you never gave it away. To be effective, you must either pay a full market rent to your children or move out entirely. This is one of the most common IHT planning mistakes.

Does my partner's unused nil-rate band transfer automatically?

It does not transfer automatically at the time of death — the surviving spouse's executors must claim it when the second spouse dies. The claim is made on the IHT return. There is no time limit on the claim, but executors should ensure it is made. It is not lost simply because a long time has passed since the first death.