Protecting your family after making a lifetime gift
Peter McGahan
Monday 9th November, 2026.
Giving is supposed to be the simple bit.
You transfer the money, watch the children or grandchildren put it towards a house, and enjoy seeing it used while you are still here.
Inheritance tax, naturally, has other ideas.
A large lifetime gift to an individual is normally a potentially exempt transfer, meaning you survive seven years and, subject to the rules, it falls out of account for inheritance tax. Die inside seven years and the gift becomes chargeable and is brought back into the inheritance tax calculation.
That seven-year gap is where protection planning is needed, because there are two different tax problems hiding inside the same gift.
Take someone who gives £200,000 to a child and has made no earlier relevant gifts. The gift sits within the current £325,000 nil-rate band (the size of your estate before which inheritance tax is payable). If the donor dies within seven years (failed gift), there may be no tax payable by the child on the gift itself. So, you might think: no problem.
Not quite.
The failed gift uses £200,000 of the nil-rate band, leaving only £125,000 to set against the rest of the estate. If the remaining estate is taxable, that lost allowance can increase the estate's inheritance tax bill by as much as £80,000 — 40 per cent of the £200,000 gift. Technical yes, but bear with me.
The child received the gift cleanly, but the people inheriting the residue of the estate have effectively picked up the tab.
Families are rarely delighted when the tax system quietly moves the bill from one pocket to another.
This is where a seven-year life policy can be useful. Insure the donor for £80,000 for seven years and, normally, write the policy into an appropriate trust for the people who would otherwise bear that extra estate tax. If the donor survives seven years, the risk disappears and the policy ends. If they die earlier, the policy provides the money to replace the nil-rate band lost to the failed gift.
Notice what we have not used: taper relief. That is because taper relief reduces tax on a gift that is itself taxable; it does not shrink the value of a gift sitting inside the nil-rate band.
Now change the gift to £400,000, again assuming no earlier relevant gifts and a full £325,000 nil-rate band. The first £325,000 uses the band. The remaining £75,000 is exposed to inheritance tax if the donor dies within seven years.
Inside the first three years, the maximum tax on that excess is £30,000.
After three years, the tax reduces: £24,000, then £18,000, £12,000 and £6,000 as each year passes to the seventh anniversary.
That is what another type of plan called a Gift Inter-Vivos policy is designed to follow. It can be set up as decreasing cover, or as layers of a plan called term assurance that fall away as the potential tax falls. You are not insuring the £400,000 gift. You are insuring the tax risk attached to it.
But there is a second problem again. The £325,000 nil-rate band has also been swallowed by the failed gift. If the residual estate is taxable, that can mean another £130,000 of inheritance tax on the estate — 40 per cent of £325,000. A Gift Inter-Vivos policy covering the recipient's tapering liability does not solve that.
So, for a sufficiently large gift, the proper protection can be two pieces: decreasing Gift Inter-Vivos cover for the tax potentially payable by the recipient, plus seven-year level term assurance for the extra tax created in the estate by the loss of the nil-rate band.
It is also why protection should follow the liability rather than the product brochure. Multiple gifts complicate the picture because earlier gifts use the nil-rate band first. Gifts into some trusts can be chargeable lifetime transfers rather than PETs. Existing gifts, exemptions, transferable nil-rate bands, the size of the residual estate and who is meant to receive the insurance proceeds, all alter the calculation.
Naturally, this is not free money. Premiums depend on age, health, underwriting and the amount of cover, so the cost must be weighed against the risk being protected.
Life assurance does not reduce the tax. It provides the cash to meet it. That can be a very different thing, but a very valuable one: you can make the gift now without leaving the recipient or the rest of the family with an unexpected tax invoice later.
It's better if a gift feels like a gift, not a nice parcel with a tax invoice tucked underneath the ribbon.
I am writing a guide to inheritance tax planning. If you would like a complimentary copy, please email info@wwfp.net and one will be sent to you when it is ready.
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
