Order of gifting
10 January 2024
Key points
- Lifetime gifts are taxed at 20% if the nil rate band has already been used up by chargeable transfers in the previous seven years
- A chargeable lifetime transfer can affect other gifts in the cumulation for up to 14 years before death (the 14 year rule)
- Chargeable transfers including failed PETs in the seven years before a trust is created can reduce the available nil rate band for periodic charges
Jump to the following sections of this guide:
Tax on lifetime gifts
Before making a lifetime gift, it's important to understand a client’s gifting history. Gifts made in the previous seven years may affect the tax payable on the current gift and, if the gift is made to a trust, the future periodic and exit charges on that trust.
Making multiple PETs
If someone makes multiple outright gifts (including gifts into Bare Trusts) these will be potentially exempt transfers (PETs). There's no tax to pay when the gift is created even if the total gifts in the previous seven years exceed the nil rate band. So there's no limit on how much can be gifted in this way without an immediate lifetime tax charge.
If the donor survives a PET by seven years, it becomes ‘exempt’ and will be outside the estate for IHT. However, if the donor dies within seven years the PET will fail and it becomes a chargeable transfer.
Making multiple CLTs
Gifts into discretionary trusts and other relevant property trusts, such as post - 2006 flexible trusts, will be chargeable lifetime transfers (CLTs). There will be a 20% tax charge if the total of all CLTs in the past seven years is greater than the nil rate band. This is the standard nil rate band of £325,000 (frozen until April 2028) with no addition for any transferable nil rate band, which can only be claimed on death.
This effectively puts a cap on what can be gifted this way without incurring a tax charge. To maximise what can be gifted tax-efficiently clients could gift up to their nil rate band every seven years. When the earliest gift becomes more than seven years old and is no longer included within the estate, a fresh gift can be made.
Combining PETs and CLTs
Some individuals may want to make a combination of outright gifts and gifts into relevant property trusts, such as a discretionary trust. Together these can offer a degree of control and flexibility on who benefits and when, while at the same time avoiding an up-front IHT charge.
If someone wishes to make lifetime gifts in excess of the nil rate band (NRB) they may choose to limit the gift into the relevant property trust to £325,000 to avoid paying a 20% tax charge. The balance of the gift could be an outright gift to an individual, a gift to an absolute trust (PET), or even into a loan trust where there is no gift for IHT as the money is lent to the trustees.
Any gifts which are PETs can be ignored when calculating the 20% lifetime tax charge on a CLT. So the order of gifting has no impact on lifetime charges.
On death within seven years, both will be chargeable transfers and it will be the oldest gift which has first call on the nil rate band. The order of the gifts could determine which recipient is primarily responsible for paying the tax if the combined gifts are greater than the nil rate band.
It's also worth noting that making the PET before the CLT could have an impact on periodic and exit charges for the trust the CLT was paid into.
Death within seven years of making a gift
When someone dies, gifts in the last seven years need to be reviewed. PETs will become chargeable transfers, and gifts that were originally CLTs will need to be re-assessed. There's no tax on chargeable transfers which fall within the nil rate band (NRB). However, this will mean that there's less nil rate band available for other assets within the estate and it may mean the estate pays more tax as a result.
The nil rate band at death, including any transferable nil rate band, is used to calculate the tax on chargeable transfers in chronological order. So the earliest failed PET or CLT will get first use of the nil rate band.
The tax on chargeable transfers and failed PETs in excess of the nil rate band at death will be recalculated at 40%. It's the recipient of the gift who is primarily responsible for paying the tax.
The gift is a chargeable lifetime transfer and IHT is due at 20% on the excess above the nil rate band.
The trustees must pay IHT of £15,000 (£400,000 - £325,000 x 20%). Mrs White dies just over four years after making the gift when the nil rate band is still £325,000. The transfer is now chargeable at 40% (less taper relief) and with credit given for the lifetime IHT already paid.
| IHT payable | £3,000 | |
| Chargeable transfer on death | £400,000 | |
| Nil rate band | (£325,000) | |
| Excess | £75,000 | |
| At death rate | £75,000 x 40% | £30,000 |
| Taper relief (4 - 5 years) | £30,000 x 40% | (£12,000) |
| IHT liability on death | £30,000 - £12,000 | £18,000 |
| Tax already paid on CLT | (£15,000) |
‘14 year rule’
There's no tax payable on gifts made more than seven years before death. However, a CLT made more than seven years before death can affect the amount of tax payable on failed PETs or CLTs. This is often referred to as ‘the 14 year rule’.
The tax on gifts in the seven years before death must be recalculated at the death rate of 40%. Any chargeable transfers in the seven years prior to the gift will reduce the available nil rate band for the gift being re-assessed, and so increase the tax on it.
- He also made a PET of £200,000 to his son John on 1 June 2021
- He dies on 1 May 2024, leaving an estate of £300,000
- There was no transferable or residential nil rate band
- No further IHT payable on CLT as it was made more than seven years before death
- PET made within seven years will become chargeable
- CLT was within seven years of failed PET and will reduce the NRB for the PET.
- IHT on PET, payable by John:
[£200,000 - (£325,000 - £185,000)] x 40% = £24,000 - IHT on estate payable by personal representatives:
[£300,000 - (£325,000 - £200,000)] x 40% = £70,000
If Henry had waited until 1 July 2021 to make the gift to his son (seven years after the CLT), it would have benefited from a full NRB and saved IHT of £24,000.
PETs more than seven years old will have become ‘exempt’ and will not affect the tax on later gifts.
Impact of gifts on trust periodic charges
Relevant property trusts, such as discretionary trusts, are assessed to IHT every 10 years (periodic or principal charge) or when capital leaves the trust (exit charge).
The trust has its own IHT nil rate band for calculating periodic and exit charges. But it will be reduced by any chargeable transfers, including failed PETs, in the seven years before the trust was created.
The trust is valued at £300,000 at the 10 year anniversary on 1 May 2024. There have been no exits or additions to the trust.
| Periodic charge | |
| Periodic charge (£175,000 x 6%) | £10,500 |
| Value at 10th anniversary | £300,000 |
| Nil rate band (£325,000 - £200,000) | (£125,000) |
| Excess | £175,000 |
Had Richard made the gift to his son one year later, after the trust was created, the trust would have a full nil rate band and there would be no periodic charge.
Order of gifting
If someone is planning to make a series of gifts, whether these are outright gifts, gifts to new trusts or even loans to new trusts, the order they are made can affect subsequent periodic and exit charges on the trusts. Gifting in the following order is likely to have the least impact on these charges:
- Loan trusts
There's no transfer of value on the creation of a loan trust, but it is still subject to periodic and exit charges (unless it is an absolute trust).
Creating a loan trust before a gift into another relevant property trust means both will benefit from a full nil rate band at the periodic charge date (assuming there are no other chargeable transfers in the previous seven years). If the order were reversed, the loan trust may have to pay IHT on an exit or periodic charge date because the prior CLT will reduce the loan trust nil rate band. - Chargeable lifetime transfers (CLT)
These include gifts to all discretionary and most IIP trusts. By making a CLT before a PET, should the PET become chargeable (i.e. if death occurs within seven years) it will not eat into the nil rate band available to the trust – it was made after the trust, not before it. This may reduce or avoid periodic and exit charges on the trust. - Potentially exempt transfers (PET)
Outright gifts and gifts into absolute trusts are not subject to periodic charges. However, if a PET is made before a gift into a relevant property trust, it could reduce the nil rate band available to the trust if the donor fails to survive for seven years. - Exempt transfers
Gifts which are covered by an exemption such as the annual exempt amount (£3,000), or normal expenditure out of income, can really be made at any time without consequence to the nil rate band available to a relevant property trust.
When considering any lifetime IHT on the actual CLTs, the order matters less as loan trusts and PETs can be ignored whether they are made before or after the CLT. If, however, an individual is considering lifetime gifts in excess of the IHT nil rate band (NRB) they may choose to limit the CLT to no more than the NRB with the balance going to a loan trust or an absolute trust (PET).
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