A sweeping change to inheritance tax being considered by Rachel Reeves could result in people passing money to family and loved ones earlier on – and ultimately paying less in care costs.
The Chancellor is reported to be considering changing the seven-year rule around gifting as part of a Budget she is characterising as a “total reset“.
The rule, which has been in place for close to 50 years, means that any gifts to people made seven years before death are not liable for inheritance tax (IHT).
It is a major consideration for individuals wishing to limit their exposure to the nation’s least favourite tax.
Ms Reeves is considering extending the rule to 10 years, according to a report in the Financial Times, in theory so more people become eligible to pay it.
The seven-year rule was introduced under Margaret Thatcher in 1986 (initially it was one year, but rose to seven over time).
If you die within seven years, the gift will be subject to no IHT, but die before and the estate pays a sliding scale of tax known as taper relief. If the person making the gift died within three years it would be taxed at 40 per cent, but this rate falls in increments, so if they died six to seven years after making the gift, the tax rate would be 8 per cent.
However Ms Reeves, who is aiming to close a £40bn government funding gap, is said to be considering changing this rule after studying a 2019 report by the now-defunct Office of Tax Simplification.
Extending the rule would make it trickier for wealthy people to pass on their assets without paying IHT, as they would need to live longer to do so.
“People would be encouraged to make gifts sooner if this was introduced – with the added benefit of potentially reducing the gift makers’ assets such that they may be unable to pay for social care,” says Simon Rothenberg, partner at Blick Rothenberg tax and accounting advisers.
He adds that it is not known if there will be additional rules introduced in the Budget to make it harder for people to gift their assets to avoid paying for social care.
Robert Salter, also a partner at Blick Rothenberg, points out the move is more likely to change the behaviour of wealthier people who have more to pass on – as they may have more money to easily give away outside the home they live in. He said his clients “overwhelmingly want to live in the main home as long as they can, and downsize when they have to for health or practical reasons, but often not just for tax reasons alone.”
Beth Joslyn, senior technical consultant at AJ Bell, says: “This change would mean the risk of larger penalties for waiting to gift assets.
“Individuals who plan to mitigate IHT would need to act sooner, for example by passing on gifts earlier in life. However, this requires extensive and careful planning at the best of times, and with ten years covering a significant portion of anyone’s life and no guarantee what future expenses, like care costs, might arise, it isn’t easy to predict how it could affect you and your family.”
Were Ms Reeves to introduce this change, then usual and best practice would be to give advance notice so people could amend their financial plans without being caught out. However, for this Budget, the stated aim is to look at tax-raising measures that will see HMRC boost its coffers in the near future.
The previous financial year saw IHT receipts hit a record-breaking £7.1bn for the Treasury – and 2023/24 looks to exceed that total.
Should the Chancellor implement such a change straight away, it would cause major controversy, as it could reduce people’s trust in the Government. It could also signal to businesses that the Government chops and changes its mind and so is to be less trusted.
Mr Salter points out that while it is not usual to bring in tax changes immediately, it would be the most profitable route for HMRC, as it would mean people would not have had a chance to amend their finances to avoid the new IHT thresholds.
“It’s not the way the system usually works – you don’t usually change these things and say ‘tough luck’ – but there is nothing to say the Government cannot do this,” he adds.
