Inheritance Tax – the basics and the Nil Rate Band and Residence Nil Rate Band
If you thought Inheritance Tax (IHT) was just for extremely wealthy people to worry about, think again. Rising property prices have meant more estates than ever are likely to face an IHT bill. If your estate has an IHT liability, your beneficiaries will have to pay the IHT. This may not be the kind of legacy most people think of leaving behind whereas other clients accept taxation as part and parcel of life/and death.
The good news is that there are plenty of things you can do – in your lifetime – to take care of a potential IHT problem. But finding the right options for you will depend on your personal circumstances and your appetite for lifetime tax planning. There are many ways to reduce IHT, including making gifts to friends, family or charities and using trusts. It is always worth consulting with us to ensure that you understand the mechanics and taxation of each option. We can provide comprehensive advice about reducing your IHT exposure.
If you do not have family that you particularly wish to benefit, spending your money improving or enjoying your life is an excellent way of reducing the eventual IHT bill. We offer pragmatic and cautionary advice to ensure that any IHT planning under consideration leaves you with sufficient wealth to maintain the quality of your life and sufficient capital/income to meet your ever-changing needs.
How does it work?
IHT is paid on the value of the assets that a person leaves behind when they die. It can also apply to some gifts that are made during lifetime.
If you are married, or have a civil partner, then you can leave your entire estate to your spouse or partner free of inheritance tax. The same principle also applies to charities. But if you want to leave some or all of your estate to family and friends, then it may be liable for IHT.
The Nil Rate Band
The Nil Rate Band (NRB) is the threshold above which IHT is payable. You can pass on assets up to the value of your nil rate band without creating an IHT bill. The nil rate band is currently £325,000 and it will remain fixed at this amount until April 2026.
You might have a smaller nil rate band on your death if you make gifts during your lifetime that aren’t covered by your tax-free gift allowances and you die within seven years of making the gifts. The value of these gifts will reduce or eliminate your nil rate band, meaning less of your estate will be passed on tax-free.
Any single person can have a maximum of two nil rate bands and two residence nil rate bands. However, these can be transferred from multiple deceased spouses for people who have had several marriages or civil partnerships. This means an individual could potentially pass up to £1 million on to the next generation without any IHT.
The Residence Nil Rate Band
The residence nil rate band (RNRB) was introduced in 2017 as an additional amount that could be passed on IHT free against the value of the family home. The residence nil rate band is currently £175,000.
In order to qualify, you must own a property or a share in a property that you have lived in at some stage, and that you leave to your direct descendants (such as children (including foster, adopted or step-children) or grandchildren, but not nieces or nephews). In addition, it only applies on death and not on gifts or any other lifetime transfers.
Importantly you cannot use a discretionary trust to pass on the home, but some other types of trust do qualify.
The RNRB is tapered down for bigger estates. For every £2 that your estate (not the value of your property) is valued over £2 million, the residence nil rate band reduces by £1. This means that estates worth more than £2.35 million may not benefit from it for a single person and £2.7 million for a married couple or value of the combined estate on second death.
The RNRB should still be available if you sell your house and move into care. The downsizing provisions mean that if you have sold your house since 8 July 2015, or do so in the future, and you leave other assets instead of your house to your lineal descendants in your Will, the RNRB can still be claimed.
Transfer of NRB & RNRB
The NRB and the RNRB can both usually be transferred between married couples and civil partners when one spouse dies, even if they died many years ago. Any unused nil rate band is transferred as a percentage rather than a specific amount of money. It’s important to note that the nil rate band is not transferred automatically and it needs to be claimed through HMRC following the death of the second person in the marriage or civil partnership.
It doesn’t matter if the nil rate bands have grown since the death of the first partner. If they didn’t use any of their nil rate band or residence nil rate band, 100% of the bands will be transferred and the surviving spouse will have two full bands to use, regardless of how much they have increased in the meantime.
So, if a married couple have an estate of £1 million it is possible that they will pay no IHT. For example, Husband dies first and leaves his entire estate to his Wife. The NRB and TNRB of Husband are unused and, on the Wife’s, subsequent death the NRB and RNRB are transferable from Husband to Wife’s executors. They can potentially claim the maximum of:
| Husband’s NRB | £325,000 |
| Wife’s NRB | £325,000 |
| Husbands RNRB | £175,000 |
| Wife’s RNRB | £175,000 |
| TOTAL FREE OF IHT | £1,000,000 |
Post Death – IHT Planning
It is possible to reduce IHT after a person has died, through a deed of variation or by placing assets into a trust. However, there are complex rules about how trusts can be used in this way.