How do nil rate bands reduce inheritance tax?

What is the nil rate band and how much is it currently? Eamonn Daly of Wright Hassall explains how nil rate bands in the UK can help you reduce inheritance tax owed on death.

Nil Rate Band Inheritance Tax

What is the nil rate band?

The nil rate band (NRB) is the threshold above which inheritance tax (IHT) is payable on the value of a person’s ‘estate’ (money, property and possessions) on death. The current amount of the NRB is £325,000 less the value of any gifts not benefiting from exemptions or reliefs made in the previous seven years.

The NRB has been set at £325,000 since 2009. It is currently proposed that it will increase annually from 2021 but only by consumer price index (CPI) inflation.

The NRB also applies to certain lifetime transfers and is used to calculate the IHT rate for trusts on the tax charges on distribution of assets and ten-year anniversaries. This article will focus however on NRBs on death.

What is the transferable nil rate band?

The NRB is transferable between the estates of spouses (for this article, ‘spouse/marriage’ also refers to civil partner/civil partnership). Any unused part of the NRB of the first spouse to die is inherited by the survivor for use in their estate.

The NRB available on the second death is increased by the percentage of the then NRB equal to the unused proportion of the NRB of the first to die:

  • So, for example, suppose that the first spouse to die only used half of the available NRB. If when the second spouse died the NRB was £400,000, the amount available in the second estate would be increased by £200,000.

Sometimes a discretionary will trust for the NRB is set up from the estate of the first of a couple to die. This ensures that use of the NRB is secured on the first death. The surviving spouse is usually a trustee and a potential beneficiary, but the value in the trust is outside of the IHT charge on the second death. The transferable NRB is not then available in the estate of the surviving spouse.

The hope is that growth in the value of assets in the trust will outstrip any increase in the NRB. There would then be less IHT payable overall than if a trust had not been used. However, if the NRB increases by more than the value of the trust by the second death, then there would be more IHT. There are also considerations around practicalities and complexity with a will trust that an individual will need to weigh up.

Can you use more than two nil rate bands?

If spouses were widowed before their final marriage, there may be more than two NRBs available to use in their estates. As well as using their own NRB, they would inherit unused portions of the NRBs of any previous spouses.

However, only a maximum value of two NRBs, so currently £650,000, can be used in any one estate. It could therefore save tax to make use of at least one NRB on the death of the first spouse of the final marriage. This would be achieved by assets passing in their will other than to the surviving spouse or charity.

The survivor could then still have the value of two NRBs, so in total use could be made of three. Similarly, where both spouses have been widowed, up to four NRBs may be available.

Is business or agricultural relief available?

Generally, it is advisable to use any available business or agricultural relief from IHT on the death of the first of a couple to die, again by passing the assets other than to spouse as well as ensuring they are dealt with under a separate legacy in the will. Otherwise the risk is that the assets qualifying for relief are disposed of, the nature of them change, or the rules change so that tax becomes due on spouse’s death.

It may be that some or all the business or farm assets held do not qualify for full relief. In this case, the non-relieved value of assets up to the amount of the available NRB only, plus any 100 per cent qualifying assets, could pass by the will to a discretionary trust. 

If the remainder of the estate passed to a spouse, there would be no IHT charge on the first death. This would achieve the least value left exposed to IHT on the second death.

Further planning can be undertaken where the surviving spouse continues with the business to enable further relief on the assets.

What is the residence nil rate band?

The residence nil rate band (RNRB) is a further allowance of currently £175,000 per person. It applies to the extent that a property which a deceased person has used as a residence passes on their death to direct descendants (including step and foster children) and those descendants’ spouses/widow(er)s.

The RNRB is transferable between spouses similarly to the main NRB. In theory every individual now has the £325,000 NRB and the £175,000 RNRB, so up to £1 million of a couple’s assets can pass free of IHT.

There are, however, limits on the RNRB. Clearly it only applies where the deceased person had descendants and owned a residence (it may still be available where the deceased disposed of a residence after 7 July 2015). It would only be fully available if the residence were worth £175,000, or £350,000 for a couple.

Finally, if the value of a person’s estate (including any assets which benefit from relief) exceeds £2 million, the RNRB is decreased. It is lost completely if the estate exceeds £2.35 million for an individual or £2.7 million for a married couple.

How can you secure the residence nil rate band?

If a person’s assets were worth more than £2 million, lifetime gifts to bring the value below this figure, even within 7 years of death, could enable more of the RNRB to be available

If the combined estate of a couple were worth more than £2 million, legacies other than to spouse on the first death could bring the estate on the second death below £2 million.

It may be that the value of the estates means that even with gifts in lifetime or on the first death, there is still no RNRB available. Some use of it, however, can be made where the value of a couple’s estates together is worth less than £4.7 million. In this case, if everything passed to the survivor on the first death, the RNRB would be unused and taper away to zero on the second death.

If instead the value of the assets that each own were split equally to bring the total value of each estate to less than £2.35 million, some RNRB would be available on the first death. A share of the residence could pass to children or a trust for them at that stage, to make use of the single RNRB available.

Making best use of the NRB and RNRB can be surprisingly tricky and clients should seek help from qualified advisers.

About the author

Eamonn Daly is a partner in the private client team at Wright Hassall, a Chartered Tax Adviser and a member of the Society of Trust and Estate Practitioners (STEP).

See also

Could gift allowance replace Inheritance Tax in the UK?

HMRC announce changes to Inheritance Tax processes during lockdown

How to protect your property after death with a life interest trust

Find out more

Inheritance Tax (GOV.UK)

Image: Getty Images

Publication date: 27 May 2020

Any opinion expressed in this article is that of the author and the author alone, and does not necessarily represent that of The Gazette.