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Deep dive into Gifting and Inheritance Tax

17 September 2020

The Prudential technical team examine Potentially Exempt Transfers (PETs) and Chargeable Lifetime Transfers (CLTs), their interaction with each other and the impact these gifts have on Inheritance Tax (IHT), why making gifts in a specific order is important and what the ‘14 year rule’ actually means.

Two main considerations when planning the IHT position of gifts are: The tax position whilst the individual is alive; the tax position after the individual has died

Other considerations include:
the value of the gifts – gifts above a certain amount may impact the availability of the nil rate band on subsequent gifts or could cause an IHT liability.
the type of gift – the value that can be transferred as a PET is unlimited and PETs will drop out of the estate provided the donor survives for 7 years. CLTs may be chargeable immediately if the accumulated CLTs are more than the nil rate band. CLTs as well as PETs will complicate matters and their interaction with one another should be examined.
succession of gifts and the order in which they are made – consideration should be given to the interaction of the types of gift and if previous gifts cause an impact on the current gift.
the position if the settlor/donor dies within 7 years of making the gift /s – although PETs are unlimited, they will become chargeable to IHT if the individual making the gift dies within 7 years of doing so.
Likewise, CLTs are also brought into the IHT calculation on death within 7 years. CLTs in excess of the nil rate band, where an entry charge was paid, will need recalculated at the death rate of 40% and any excess tax paid.

CLTs made in the seven years before a “failed PET” will also have an impact on the IHT calculation of the PET.

What are PETs and CLTs?

Potentially Exempt Transfer (PET)

This is a gift or transfer of unlimited value which has the potential to be exempt. Outright gifts such as cash sums or transfers into absolute/bare trusts are PETs.

The rules state that the individual has to survive for 7 years after making the gift for it to be exempt. So, if the individual survives for 7 years, the PET escapes IHT altogether. PETs outwith the 7 year period will never be brought into the IHT calculation.

A PET is only Potentially Exempt, so if the individual dies within 7 years of having made the gift, it “fails” and becomes a Chargeable Transfer (sometimes known as “failed PET”) for IHT purposes. This means that it will be taken into account in the individual’s IHT calculation.

Example 1a – 2 PETs in close succession and survival for 7 years
Amy gifts £500,000 to Alicia
The following year, Amy gifts £500,000 to Michael

 IHT Position
* Total gifts equal £1,000,000
* The gifts are PETs, so unlimited amounts can be given and provided Amy lives for 7 years there will be no IHT consequences
* The gifts were made a year apart, each gift will have its own 7 year period, starting on the date the gift was made.

Example 1b – PETs and death within 7 years Amy gifts £500,000 to Alicia
The following year, Amy gifts £500,000 to Michael.
Amy dies a year after making the gift to Michael

IHT Position

The timeline above shows that both PETs are in the 7 years preceding death, therefore both PETs will “fail” and become chargeable in chronological order.

The first failed PET will use all of the £325,000 nil rate band leaving £175,000 of this PET plus the full £500,000 of the second PET chargeable to IHT at 40%.

Example 2a – 2 PETs and survival for 7 years
Amy gifts £500,000 to Alicia
7 years later, Amy gifts £500,000 to Michael

IHT Position
* Total gifts equal £1,000,000
* The gifts are PETs, so unlimited amounts can be given and provided Amy lives for 7 years there will be no IHT consequences
* The gifts were made 7 years apart and each gift will have its own 7 year period.

Example 2b – PETs and death within 7 years

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