Understanding Gift Inter Vivos Policies: A Practical Tool for Inheritance Tax Planning
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When considering how best to pass wealth to loved ones during your lifetime, one commonly used strategy is making outright gifts. This can be an effective way of reducing the value of your estate for inheritance tax (IHT) purposes. However, these gifts can come with their own complexities – particularly if you die within seven years of making them. This is where a gift inter vivos policy can come into play.
In this blog, we’ll explain what a gift inter vivos policy is, where it may be used, and the advantages and disadvantages of using one as part of your estate planning strategy.
What is a Gift Inter Vivos Policy?
A gift inter vivos policy is a specific type of life insurance policy designed to cover the potential inheritance tax liability that could arise if you pass away within seven years of making a lifetime gift.
The term inter vivos is Latin and means “between the living”. It refers to gifts made during a person’s lifetime, as opposed to gifts made upon death via a will (known as testamentary gifts).
The policy pays out a lump sum that is typically equal to the IHT liability that would fall due on the gift if the donor dies within the seven-year window. The aim is to ensure that the recipient of the gift does not face a sudden tax bill if the gift later becomes chargeable to inheritance tax.
The Seven-Year Rule and Taper Relief
Before diving deeper into how these policies work, it’s useful to understand the seven-year rule in IHT.
When you give a gift to an individual and survive for seven years, it is known as a Potentially Exempt Transfer (PET). If you live beyond this period, the gift may be fully exempt from IHT. However, if you die within seven years, the gift may become chargeable to IHT.
It is important to note that gifts made to certain types of trust are Chargeable Lifetime Transfers (CLTs) which may incur an immediate lifetime tax charge. You should seek professional advice before making any gifts to ensure you understand its tax treatment.
The amount of tax due depends on how long you survive after making the gift:
• 0-3 years: 40% tax (the full rate)
• 3-4 years: 32%
• 4-5 years: 24%
• 5-6 years: 16%
• 6-7 years: 8%
• After 7 years: 0% (gift is exempt)
This is known as taper relief. Importantly, taper relief reduces the rate of tax, not the value of the gift.
How Does a Gift Inter Vivos Policy Work?
A gift inter vivos policy is a decreasing term assurance policy, typically written over a seven-year term to align with the PET period. The sum assured decreases in line with the taper relief schedule.
If the donor dies within this period, the policy pays out an amount designed to cover any IHT liability created by the gift. The proceeds of the policy are usually paid directly to the beneficiary of the original gift (or a trustee), so they can settle the tax bill without dipping into their own funds or returning part of the gift.
The policy should be written in trust so that it falls outside of the estate and can be paid quickly and directly to the intended recipient.
When Might a Gift Inter Vivos Policy Be Used?
Gift inter vivos policies are particularly useful when:
• You are making a substantial lifetime gift that could result in a tax charge if you pass away within seven years
• You want to protect the recipient of the gift from a surprise tax bill
• You want to retain control and reassurance around lifetime giving, knowing the tax position is covered
Common scenarios include:
• Gifting a large sum of money to children to help them onto the property ladder
• Transferring ownership of business assets or property during your lifetime
• Making gifts as part of a longer-term estate reduction strategy
Advantages of Using a Gift Inter Vivos Policy
1. Peace of mind – Both the donor and recipient know that the tax is covered if the worst happens.
2. Cost-effective – As the policy term is set at 7 years from the date of the gift, they can be surprisingly affordable for healthy individuals.
3. Targeted protection – The policy is tailored to a specific gift and liability, making it a precise planning tool.
4. Estate protection – By writing the policy in trust, it does not increase the estate’s value for IHT purposes.
5. Supports family wealth transfer – Enables wealth to be passed down without burdening recipients with tax complications.
Disadvantages and Considerations
1. Premium costs – If the donor is older or has health issues, premiums can be high or cover may not be available.
2. Policy term – It only covers the seven-year risk period. If the donor dies after seven years, the policy ends without value.
3. Limited to individual gifts – If you make multiple large gifts, you may need multiple policies or one large policy to cover all.
4. Does not reduce IHT – It covers the liability, but it doesn’t reduce the tax itself. It’s a funding solution, not a tax reduction tool.
Conclusion
A gift inter vivos policy is a practical and often overlooked tool in inheritance tax planning. It allows individuals to make meaningful lifetime gifts while safeguarding recipients against unexpected tax charges. For those with sufficient income or capital to afford the premiums, it can be an elegant solution that combines generosity with prudence.
As always, this kind of planning should be undertaken with the guidance of a qualified financial planner. They can assess whether such a policy is suitable in your circumstances and help you structure it tax-efficiently, particularly when working alongside trusts and other estate planning vehicles.
If you’re considering making a significant lifetime gift or would like to discuss how a gift inter vivos policy could support your wider estate planning goals, please get in touch.