Estate planning: Understanding Inheritance Tax and the Nil Rate Band

With property values increasing, more people are becoming concerned that their families may have to pay inheritance tax when they pass. However, there are a number of exemptions related to inheritance tax that can be considered when writing your Will, in this blog, we’ll look specifically at the basic nil rate band and the residence nil rate band. 

What is the Nil Rate Band?

Your estate has a threshold known as the nil rate band. Inheritance tax is not payable if the value of your estate is below this threshold. Currently, in 2023 the threshold is £325,000. 

This means that if you pass away and your total assets are worth less than £325,000,  generally, there will be no inheritance tax to pay. (However, there may be some exceptions to this, for example, if you gifted property or significant sums of money to others in the seven years leading up to your death, which add to the value of your estate for inheritance tax purposes).  

What does a transferable Nil Rate Band mean?

When you pass away, any assets you leave to your spouse or civil partner are exempt from inheritance tax.  

This means that if you gift your entire estate to your spouse there is no inheritance tax to pay and you have not used your nil rate band. This does not get lost. 

So, if the surviving spouse or civil partner then passes away, those managing their probate can claim to transfer their deceased spouse or civil partner’s nil rate band – provided it was not used on the first death. 

If the entire estate had passed between spouse or civil partners then the full nil rate band would be available. This would mean that based on the current 2023 nil rate band, the threshold of which inheritance tax would not be payable would increase to £650,000. 

The figure though, could be lower if the first spouse or civil partner had given some assets to people other than their spouse or civil partner, which were not exempt from inheritance tax and would therefore have used part of their nil rate band. 

For example, a husband gives £500k to his wife, which is exempt from inheritance tax. But, he also gives £100k to a friend, this is not exempt and would mean that £100k of his nil rate band had been used, therefore the amount that could be transferred to the wife would be reduced by £100k, i.e. it would be £225k at current 2023 rates – meaning her total threshold would be £550k when she passes away. 

There may be some other exemptions or reliefs, which could apply, but they are not the subject of this article – to try to keep the basics simple. For further help with tax planning, we recommend speaking to an accountant or financial advisor for financial advice, or a specialist probate solicitor if you are currently managing the probate of someone’s estate. 

What is the Residence Nil Rate Band?

In addition to the general nil rate band discussed above, if, when you pass away you give your main home to direct descendants (i.e. a child, a grandchild or great-grandchild – (lineal descendants) and not parents, siblings or other relatives), then an additional threshold known as the residence nil rate band can be claimed.  

With current 2023 rates, this can add another threshold of up to £175,000 to the nil rate band above, increasing one person’s nil rate threshold, to as much as £500,000 below which inheritance tax is not payable.  

To claim the residence nil rate band there needs to be a residential property included in the estate which the person who has passed away, lived in as their main home at some point.  They do not necessarily need to be living in it at the time of death but must have lived in the property at some point in their lifetime. Property they have not lived in, such as a property that they have simply rented out and held for investment purposes is not eligible. The residence nil rate band can also be claimed if the person who passed away, downsized from a more valuable property to a property worth less than £175,000 or sold a property in which they had lived in (subject to certain conditions).  

To qualify the property must pass to direct descendants as mentioned. This includes a child who is adopted and can include a fostered child (subject to certain conditions). It also includes step-children but only children of the deceased’s spouse or civil partner. It can even include the spouse or civil partner of a direct descendant such as a son-in-law, provided they have not remarried or entered into a new civil partnership before the death of the person leaving the estate.

To qualify the home does not need to be passed as a specific gift as a single asset but could be included as part of the residuary estate.  

If the value of the estate is over the initial nil rate band of £325,000, this additional residence nil rate band can be claimed, to increase the nil rate threshold up to £500,000. There are, however, some exceptions in relation to high-value estates, but most people will be eligible to claim this. 

Can you transfer the Residence Nil Rate Band?

As mentioned above, you can in some situations, transfer the general nil rate band to your spouse or civil partner. 

It is also possible to transfer unused residence nil rate band. If for example, a couple are married and the husband dies first leaving his estate to his wife, there is no inheritance tax to pay as a gift to a spouse is exempt. The wife then leaves her estate to their children.  She has her own nil rate band of £325,000, her husband’s transferred nil rate band of £325,000 and her own residence nil rate band of up to £175,000. In addition, the wife can claim her late husband’s residence nil rate band of up to £175,000. This means that as a married couple or civil partnership, the joint threshold below which inheritance tax is not payable can in most situations, be increased to £1 million without having to worry about inheritance tax.  

Given inheritance tax is payable at 40% where it is due, being aware of these nil rate bands is important and something that can avoid unnecessary worries about what will happen after you pass.  

As mentioned at the outset of this article, there are some other exemptions that can be claimed in relation to inheritance tax – but this article deals only with the two nil rate bands which will benefit many. 

There have been circumstances when people have dealt with probate without advice and have paid tax, that could have been avoided as they were not aware of the ability to transfer these nil rate bands. 

When dealing with tax it is always advisable to seek professional advice from an accountant/financial adviser and to seek specialist legal advice when dealing with probate.  

If you need advice or assistance with making a Will or handling the probate of an estate, speak to our specialist Wills and Probate team on 01484 442 700 (Holmfirth office) or 0161 427 0084 (Marple Bridge office) or email info@bridgelawsolicitors.co.uk. 

Written by Carol-Anne Baker