How could the inheritance tax seven-year rule change?

There has been speculation that the generous seven-year rule that allows families to pass on a potentially unlimited amount inheritance tax (IHT)-free could be abolished in the Autumn Budget.

Speculation about the Budget has been rife, and savers should make sure to take any rumours with a healthy bucket of salt. Making rushed decisions because of rumours could prove costly in the long term.

However, speculation is an opportunity to get your head around how the current rules work, what might change, and consider all the gifting allowances available to you.

How does the seven-year rule work?

Under the seven-year rule, you can pass on as much wealth as you like as long as you live another seven years after making the gift. If you die before the seven years are up, the value of any gifts made during that period will be notionally added back into your estate for IHT calculation purposes.

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Could the government remove the seven-year rule entirely?

There are rumours the seven-year rule could be scrapped entirely, and the government could instead impose a lifetime cap on how much families can give away IHT-free.

However, such a cap would be very difficult to enforce - raising questions such as whether pocket money you give to young children is included and how families are supposed to keep accurate records over such a long period.

Many gifts from parents to their children are informal - for example, lending some money to a teenager to go on holiday with their friends - and so the administrative burden on HM Revenue & Customs (HMRC) to check for unreported transfers would be significant.

There could be significant knock-on effects for the housing market too if parents and grandparents are unable to make gifts to help children onto the property ladder.

How else might the seven-year rule change?

Alternatively, the Treasury could extend the length of time you need to live before a gift becomes IHT-exempt. Extending this to eight years or more would likely result in more gifts falling into the IHT net.

It could also look to abolish taper relief. This is where the rate of IHT applied to gifts made within seven years of a person’s death tapers down - from the full 40% if the gift is made within three years of death to just 8% if the gift is made between six and seven years before their death. However, it’s important to note that the taper relief only applies if the total value of gifts given in those seven years exceeds the IHT nil-rate band allowance of £325,000.

Essentially, gifts made in the past seven years are the first things added back to your estate for IHT purposes and the first things to use up your nil-rate band allowance - leaving less of the nil-rate band allowance for your other assets, such as investments and savings. The taper relief only applies to gifts that fall outside of the available IHT exemptions on death.

The system is very often misunderstood, and the government could look to abolish the taper relief entirely.

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What about other IHT rules?

In recent years both a cross-party parliamentary group and the Office of Tax Simplification have called for the Capital Gains Tax (CGT) uplift on gifts exempt from IHT to be scrapped.

Currently, when you inherit assets on someone's death, those assets get a “step-up” in value for CGT. This means you don’t pay CGT on gains prior to the person’s death. CGT is normally paid on the sale of a taxable asset, where it has increased in value during the period of ownership. This tax is chargeable to the individual, so on death, any capital gain on an asset is discounted and the current market value at the date of death is used to calculate the estate value for IHT purposes.

Say your parents bought a property for £100,000 and by the time they pass away it is worth £300,000. They pass it on to you upon their death and we assume no IHT is due as the estate falls below the threshold. If you sold the property for market value (£300,000) then there should be no CGT to pay either, as there has been no increase in value since you inherited it. However, if this CGT uplift were removed, you would have to pay tax on the gain since the asset was purchased which, in this case, is £200,000. For a basic rate taxpayer, HMRC would take 18% of that - or £36,000 - and for a higher rate taxpayer the bill would be £48,000, reflecting a 24% rate.

It's important to remember that all of the potential changes listed above are pure speculation and nothing has been confirmed.

What other gifting allowances could families use?

Even if the seven-year rule does change, there are other gifting allowances families can make use of.

For example, you can give away the following and those gifts should be immediately exempt for IHT purposes:

• Up to £3,000 per tax year using the annual gift allowance
• Up to £5,000 per child for a wedding (the amount is slightly less for grandchildren or other people)
• A potentially unlimited amount so long as the gifts are made on a regular basis out of your monthly income, and you can afford the payments after meeting your usual living costs. This is known as the allowance for ‘normal expenditure out of income’.
• Up to £250 per person to as many people as you like each tax year using the small gift allowance. However, the small gift allowance cannot be combined with any other allowance.

Inheritance tax is an extremely complex area of financial planning. If you’re unsure of anything, it would be best to speak to a financial adviser.

• Find out more about how inheritance tax works

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Eligibility to invest in an ISA and tax treatment depends on personal circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of   Fidelity’s advisers or an authorised financial adviser of your choice.