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Getting to grips with the Nil-Rate Band for Inheritance Tax

Inheritance Tax (IHT) is one of the most controversial taxes and it’s one that can lead to much confusion. If you’re planning how you’ll pass your wealth on to loved ones, IHT can be difficult to get your head around. Once you throw in Nil-Rate Bands, you might be at a loss as to what your beneficiaries could pay and how to mitigate it if necessary.

First, the basics of IHT. It’s a tax paid on your estate when you die. The current standard rate of IHT is 40%. The complexity starts when assessing who will need to pay IHT. Your estate includes most of your assets, including cash, property, possessions and investments. If your estate falls under certain thresholds, known as Nil-Rate Bands, no IHT will be due.

If your estate is liable for IHT, there are steps you can take to reduce the bill, or in some cases eliminate it entirely.

Who needs to pay Inheritance Tax?

If you choose to pass on your wealth to a spouse or civil partner, you will be exempt from IHT. Furthermore, you can pass on any unused allowance from Nil-Rate Bands on to them, increasing the amount they can pass on to loved ones without IHT being due.

If you’re passing on wealth to anyone else, including children and grandchildren, IHT may be due depending on the value of your estate. There are two Nil-Rate Bands to be aware of:

The Nil-Rate Band: The basic Nil-Rate Band threshold is currently set at £325,000. If the value of your entire estate is below this amount, no IHT will be due.

The Residence Nil-Rate Band: If you’re leaving your main home to your children or grandchildren, you may also be able to take advantage of the Residence Nil-Rate Band. However, to do so, your estate must be worth less than £2 million. The current Residence Nil-Rate Band is £125,000. The threshold is increasing by £25,000 a year and will reach a maximum £175,000 in 2020/21.

The two Nil-Rate Bands mean you can currently pass up to £450,000 to loved ones without IHT being due. Should you share your Nil-Rate Band with a partner, your family can inherit up to £900,000 without having to worry about an IHT bill.

IHT Nil-Rate Bands in practice

If IHT still seems complex, this scenario gives you an example of it working in practice:

David and Jane are a married couple with an adult son, Sam. The home the couple live in together is valued at £400,000. They also have additional savings and investments totalling £1 million. All their assets are jointly owned.

David dies in 2015, so ownership of all the assets pass to Jane without any IHT being due. David’s unused Nil-Rate Band and Residence Nil-Rate Band also pass to Jane.

Three years later, Jane dies leaving her entire estate to her son Sam. As Jane’s estate benefits from her own Nil-Rate Bands and David’s, £900,000 is exempt from IHT. The value above this threshold is liable for IHT at a rate of 40%. This means Sam will face an IHT bill of £200,000. In total, he receives £1.2 million from his parent’s estate, minus other costs for administering.

What to do if your estate may be liable for IHT

The combination of the two thresholds, plus the ability to pass unused allowances on to spouses or civil partners, means that many estates don’t pay IHT. It’s estimated that one in 20 people pay the ‘death tax’. However, HMRC collected a record £5.2 billion from IHT in 2017/18 following an increase of 8% (£388 million) from the previous year.

As property prices have increased significantly over the last few decades, some families may be facing an IHT bill without realising it. Understanding the value of your estate and the thresholds is an important step. If IHT is likely to be an issue you face, there are some steps you can take to reduce liability, including:

  • Make a will: The first step you should take is to make a will, or, if you already have one in place, update your existing will. This will ensure that your assets are distributed according to your wishes, rather than intestacy rules. It also provides you with an opportunity to ensure you’re not paying IHT that could be avoided.
  • Use a trust: In some cases, it may be possible to put part of your wealth outside of your estate for IHT purposes by using trusts. For example, you can create a trust that will benefit grandchildren once they reach adulthood. This can be a complex matter and it’s not a solution that suits all situations. If you’d like to discuss using trusts, please contact us.
  • Gift assets now: You don’t have to wait until you pass away to provide financial support to loved ones. Gifting assets now can mean you get to see the benefits of your generosity and reduce IHT liability. There are some gifts that are immediately exempt from IHT, but others may not be should you die within seven years of them being received. Make sure you understand the gifting allowance before proceeding.
  • Leave some of your estate to charity: The standard IHT rate can be reduced if you leave 10% or more of your estate to charity. This would reduce the rate from 40% to 36%. Depending on the value of your estate, it can mean paying out less, as well as supporting causes that are close to your heart.
  • Take out life insurance: If your estate will be liable for IHT and you’re worried about how your loved ones will pay it, a life insurance policy can help. With the right set-up, it will pay out a lump sum on death, covering your IHT bill. As a result, the value of your estate can remain intact for your loved ones to inherit.

If you’d like to discuss the value of your estate and potential IHT liability, please contact us. We’ll help you understand the options open to you if IHT is a concern.

Please note: Tax and estate planning is not regulated by the Financial Conduct Authority.