Families giving away money or property to reduce inheritance tax could unknowingly fall into a costly trap.
Misunderstanding how taper relief works may leave thousands of pounds exposed to tax, even when a gift was made more than six years before death.
Gifting assets during a person's lifetime can reduce the value of their estate and potentially lower the inheritance tax bill faced by their loved ones.
Under the seven-year rule, most outright gifts fall outside an estate for inheritance tax purposes if the person survives for seven complete years after making them.
Taper relief may reduce the tax charged when someone dies between three and seven years after making a gift, but the rules are commonly misunderstood.
Many people wrongly believe taper relief applies to every gift or reduces the value of the gift itself.
In reality, the relief only applies when the combined value of non-exempt gifts made during the seven years before death exceeds the £325,000 nil-rate band.
It reduces the tax charged on the amount above that threshold, rather than reducing the value of the gift.
AJ Bell demonstrated the rules using the example of Sarah, who gives £400,000 to her niece and dies just over six years later.
Her total wealth was £1million before the gift, leaving an estate worth £600,000 at the time of her death. She also had the standard £325,000 nil-rate band available.
At first glance, it may appear that Sarah's estate could use the full £325,000 allowance, while her earlier gift benefits from the reduced eight per cent taper-relief rate.
However, gifts made before death use the nil-rate band first.
Sarah's £400,000 gift therefore uses her entire £325,000 allowance, leaving £75,000 exposed to inheritance tax.
Because she survived for more than six years after making the gift, taper relief reduces the tax rate on the £75,000 to eight per cent, producing a £6,000 charge.
However, no nil-rate band remains to protect her £600,000 estate, meaning the full amount is taxed at 40 per cent. This creates a further £240,000 charge and takes the total inheritance tax bill to £246,000.
The taper-relief rate depends on how long a person survives after making a gift.
Tax can be charged at 40 per cent if death occurs within three years, falling to 32 per cent after three years, 24 per cent after four, 16 per cent after five and eight per cent after six.
Most outright gifts become free from inheritance tax once seven complete years have passed.
For inheritance tax purposes, a gift can include cash, property, investments or artwork. It can also include the loss in value when an asset is sold or transferred for less than its open-market price.
Charlene Young, senior pensions and savings expert at AJ Bell, notes that the government's inheritance tax receipts have more than doubled over the past decade, driven by increasing asset values combined with frozen allowances.
"This, together with the April 2027 changes that will bring unused pensions into the value of estates, has led to many more people considering using gifts to reduce the value of their estates for tax purposes," she said.
Ms Young emphasises that professional guidance proves invaluable in this complex area. "Get the rules wrong, and you run the risk of leaving your loved ones with less than you'd hoped for as the gift is still part of your estate," she warns.
Certain transfers remain entirely exempt, including those between spouses, civil partners, and donations to charities or political parties.
