UK Inheritance Tax Gifting Rules: The 7-Year Rule vs. Annual Exemptions Explained (2025 Guide)

Picture this: You’re a successful business owner in Surrey, and you want to gift £100,000 to your daughter to help her buy her first home. You’ve heard of the "7-year rule" and "tax-free allowances," but the terminology feels like a financial minefield. Your core question, the one that keeps you up at night, is simple: Will this generous gift be hit by a 40% Inheritance Tax (IHT) bill after you pass away?

If you've felt this confusion, you're certainly not alone. Inheritance Tax is often cited as one of the UK’s most complicated taxes, primarily because the rules governing gifts are filled with pitfalls. Misunderstanding the difference between a Potentially Exempt Transfer (PET), a Chargeable Lifetime Transfer (CLT), and the various annual exemptions can cost an estate—and its beneficiaries—tens of thousands of pounds. This guide, created by the research team at FinTools UK, is designed to demystify the 7-year rule and show you exactly how your gifting strategy can impact your estate's IHT liability.

The Fundamental Concept: PETs, CLTs, and the Seven-Year Clock

Before we explore the rules, let’s simplify the core vocabulary. When you give away money or assets, HMRC categorises the transfer into one of two groups: a **Potentially Exempt Transfer (PET)** or a **Chargeable Lifetime Transfer (CLT)**. Think of this initial classification as the starting gun for the IHT race—it determines if, and when, the seven-year clock begins to tick.

A **Potentially Exempt Transfer (PET)** is a gift made directly to an individual, such as your son, daughter, or friend. The 'potentially' part is key: if you, the donor, survive for seven years after making the PET, the gift becomes completely exempt from IHT, and it falls out of your estate. No IHT is due. This is the goal of most personal gifting strategies. Conversely, if you die within seven years, the PET fails and becomes a chargeable gift, reducing your estate’s available Nil-Rate Band (NRB).

A **Chargeable Lifetime Transfer (CLT)**, on the other hand, is a gift made into a trust (most commonly a discretionary trust). This is immediately chargeable to IHT at 20% on any amount above the NRB, though this is rarely paid upfront in practice. The seven-year rule still applies for reducing the value of the gift for IHT purposes upon death, but the treatment during your lifetime is different.

The **7-Year Rule** itself is a mechanism designed to stop people from giving away their entire fortune on their deathbed to avoid tax. It is the core defensive strategy in IHT planning. HMRC data shows that the number of estates paying IHT reached 27,000 in 2020-21, a 10% increase from the previous year, highlighting the growing necessity of sound gifting strategies (HMRC Statistics, 2023).

Scenario-Based Breakdown: When is a Gift Truly Tax-Free?

Making a gift exempt from Inheritance Tax comes down to using a combination of the available tax-free allowances *before* you resort to relying solely on the seven-year countdown. These allowances are your secret weapons—they reduce your estate immediately, regardless of when you pass away. The table below breaks down the most common gifting scenarios and the tax treatment for each. As you can see, the same £20,000 gift can have four completely different tax outcomes depending on how you structure it.

The table reveals a crucial lesson: The best gifts are those that utilise the exemptions first. The £3,000 Annual Exemption is particularly powerful because it is instantly tax-free. If you forgot to use it last year, you can carry forward the previous year's allowance to the current year, giving you a potential tax-free gifting allowance of up to **£6,000** in a single tax year. This simple move can immediately reduce your taxable estate, regardless of the 7-year countdown.

Deep Dive: Taper Relief and the £325,000 Nil-Rate Band

So, what happens if you make a large gift—a PET—and die within the seven-year window? This is where the concept of Taper Relief comes into play, and it’s a source of immense confusion. Most people assume Taper Relief automatically reduces the tax bill, but here's the thing: Taper Relief only reduces the *rate* of tax on the gift; it doesn’t apply unless the value of the failed PET, when combined with any previous PETs, exceeds your available Nil-Rate Band (£325,000).

Let's use an analogy to clarify: Think of the £325,000 NRB as a bucket of tax-free allowance. When a PET fails, it’s the first thing to fill that bucket. Only the excess amount—the overflow—becomes taxable at the 40% IHT rate. Taper Relief then reduces the tax due on that overflow, based on how long the donor lived after making the gift.

For example, if you gift £325,000 and die 4 years later, the failed PET uses up your entire NRB. Your beneficiaries pay no IHT on the gift itself, but your entire estate is now taxable from £1 upwards. If you gifted £500,000 and died 4 years later, the £325,000 NRB is used, leaving a £175,000 portion of the gift that is chargeable. This £175,000 is where Taper Relief applies.

Taper Relief Rate Breakdown (2025/26)

1. Within 3 years: IHT charged at 40% (No Taper Relief)

2. 3 to 4 years: IHT charged at 32% (20% reduction)

3. 4 to 5 years: IHT charged at 24% (40% reduction)

4. 5 to 6 years: IHT charged at 16% (60% reduction)

5. 6 to 7 years: IHT charged at 8% (80% reduction)

6. 7+ years: IHT charged at 0% (Fully exempt)

The goal is always to survive seven years, but if you don't, Taper Relief can soften the blow on the portion of the gift that exceeds the NRB. Importantly, the existence of a failed PET does not just affect the gift—it reduces your available NRB, meaning the rest of your estate starts paying 40% tax much sooner. Recent data shows that the IHT Nil-Rate Band has remained frozen at its current level for over 15 years, significantly increasing the number of estates now caught by this tax (IFS Report, 2024).

Edge Cases: The Power of Gifting from Income

While the 7-year rule dominates IHT discussion, the single most powerful and often under-utilised exemption is the **Gifts Out of Normal Expenditure Out of Income** exemption. This is an exemption where the seven-year rule does not apply at all.

The key here is proving that the gift was made from your *surplus income* and did not impact your standard of living. It allows you to make regular gifts of any size—even large amounts for things like school fees or insurance premiums—provided two conditions are met: the gifts must be part of your normal expenditure, and they must be made out of your income (HMRC guidance IHTM14231, 2025). For example, if your pension income is £50,000 per year, and your expenditure is £30,000, you have £20,000 of surplus income you can gift away entirely tax-free, without a seven-year waiting period. I've seen this used by retirees who have a large pension and wish to regularly fund a child's mortgage over several years, immediately reducing their estate without any IHT risk.

Common Questions About Inheritance Tax Gifting

Based on questions I’ve seen across UK personal finance forums and specialist communities, here are the three most common points of confusion regarding IHT gifting:

Does the seven-year rule apply to gifts between spouses?

No. Gifts between spouses or civil partners are always **exempt** from Inheritance Tax, regardless of the amount. This is a powerful, instant relief. For instance, if you gift your entire portfolio of shares to your wife, no IHT is due on that transfer. However, be aware that if the spouse who received the gift dies shortly after, the asset (and its full value) then forms part of their estate, potentially making the final estate taxable.

Can I gift money tax-free for a wedding?

Yes, the Wedding or Civil Partnership Gift Exemption is a special allowance. You can gift up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else. This allowance can be used in addition to your £3,000 Annual Exemption. The gift must be made before the ceremony and be conditional on the marriage taking place. If the wedding is called off, the gift reverts to being a PET, and the 7-year rule would apply.

If I use Taper Relief, does my final estate still pay 40% IHT?

This is the biggest myth. Taper Relief reduces the tax on the *gift* itself, but a failed PET still uses up the donor’s Nil-Rate Band (£325,000). The first gifts made in the seven years before death use the NRB first. If the combined value of all failed PETs is more than the NRB, the excess is taxed, potentially with Taper Relief. However, the rest of the estate's assets (house, bank accounts) will also start paying IHT as soon as the NRB is exhausted by those failed gifts.

Conclusion: Your Next Steps

Understanding UK Inheritance Tax gifting comes down to three core actions: **Act early**, **utilise all available exemptions**, and **keep meticulous records**. The seven-year rule is your main goal for large gifts, but the real power lies in consistently using the smaller, instant tax-free allowances like the £3,000 Annual Exemption and the Gifts Out of Income exemption.

If you are planning to make a large gift, your first step should be to audit your income to see if you have sufficient surplus income to use the Normal Expenditure exemption. Next, make sure you are claiming the £3,000 Annual Exemption every year, using the one-year carry-forward if necessary. By starting the seven-year clock today and systematically using the instant reliefs, you can significantly shrink the potential IHT liability on your estate. However, IHT planning is intricate, and the rules around PETs, CLTs, and especially gifts from income require clear documentation to satisfy HMRC—this guide provides a robust framework, but for your specific estate and financial circumstances, always consult a qualified tax or estate planning professional.