There is a tax-free allowance (known as the ‘nil rate band’) which is the amount of your estate which is free from inheritance tax. It is currently set at £325,000 and this has been fixed until 2021.
This is a maximum amount, as the allowance can be used up by:
chargeable lifetime gifts (for example, gifts to trusts or companies); and
gifts within seven years of your death.
For deaths on or after 6 April 2017, there will also be an additional allowance (known as the residence nil rate band) where a residence is given to a direct descendant. More information on this can be found below.
Residence nil rate band
From the tax year 2017-2018 (so from 6 April 2017), an additional nil rate band will be available if you leave your interest in a residential property to a direct descendant (i.e. your child, step-child, foster child or adopted child and their lineal descendants).
This residence nil rate band will start at £100,000 for the tax year 2017-2018 and will increase to £175,000 by 2020-2021. From 2020-2021 it is expected to rise in line with the Consumer Prices Index (the official measure of inflation of UK consumer prices).
If your estate is worth over £2 million, the residence nil rate band will be tapered (i.e. reduced in value) at a rate of £1 for every £2 over this threshold. This threshold will also rise in line with the Consumer Prices Index.
The residence nil rate band is also available if you downsize or cease to own a home on or after 8 July 2015, and assets of an equivalent value - up to the value of the residence nil rate band - are passed on your death to your direct descendants.
Can you transfer your nil rate band to your spouse or civil partner?
The simple answer is yes. If you die with all or any part of your £325,000 allowance unused, the unused percentage of the allowance can be claimed by your spouse’s or civil partner’s personal representatives when they die. This means that if you want all of your estate to pass to your spouse or civil partner, you will not waste your allowance as it will be able to be used on their death instead.
The ability to transfer nil rate bands applies to deaths on or after 9 October 2007. For example, on John’s death in 2012, his estate was worth £700,000. His full allowance of £325,00 was intact and he left his estate to his wife Sue. Sue died in 2014 with assets of £900,000 in her estate (and an unused nil rate band). She leaves everything to her daughter Anna.
The spouse exemption applies to the assets passing to Sue on John’s death, so no inheritance tax is due.
On Sue’s death, her executors can claim John’s unused nil rate band of £325,000 in addition to Sue’s own nil rate band of £325,000. This means that inheritance tax is only payable on the remaining £250,000 of Sue’s estate.
For deaths on or after 6 April 2017, an unused residence nil rate band will also be able to be carried forward to a surviving spouse or civil partner.
Combining nil rate bands
The effect of the residence nil rate band, together with the existing transferable nil rate band, will be to allow up to £1 million (by 2020-2021) to be passed free of inheritance tax on the death of the survivor of two spouses or civil partners. The exact amount would depend on how much of each nil rate band is unused when they die. The table below shows how the allowances can be combined and how the allowances will change over the period 2017-2020:
Date of death of second spouse or civil partner to die (on or after) | Nil rate band of second spouse or civil partner to die | Transferable nil rate band of first spouse or civil partner to die | Residence nil rate band of second spouse or civil partner to die | Transferable residence nil rate band of first spouse or civil partner to die | Combined total nil rate band |
6 April 2017 | £325,000 | £325,000 | £100,000 | £100,000 | £850,000 |
6 April 2018 | £325,000 | £325,000 | £125,000 | £125,000 | £900,000 |
6 April 2019 | £325,000 | £325,000 | £150,000 | £150,000 | £950,000 |
6 April 2020 | £325,000 | £325,000 | £175,000 | £175,000 | £1,000,000 |
Does a Will need to mention the nil rate band?
In the majority of cases the answer is no; the allowance will simply pass to your spouse or civil partner to be used on their death.
There are some circumstances, however, where it may be beneficial to carve out the tax-free allowance in your Will. If you are leaving your residuary estate to a beneficiary who is exempt from inheritance tax (such as your spouse), you can leave the nil rate band on trust for a group of beneficiaries (including ones that are not exempt from inheritance tax).
Examples of where a nil rate band trust may be relevant are:
Care home fees – assets in trust may not be taken into consideration if your spouse or civil partner is assessed for care home fees.
Highly appreciating assets (e.g. land with planning permission) – these assets may increase in value faster than the tax-free allowance.
Flexibility – to ensure the correct family members benefit.
More than one marriage or civil partnership – to enable more than one allowance to be used on your spouse’s or civil partner’s death.
If on the death of the first spouse or civil partner it is decided that a nil rate band trust is not useful or appropriate, it can be wound up very easily by distributing all of the assets within two years of the first spouse’s or civil partner’s death.
Nil rate band trusts are generally only considered useful for couples or civil partners who want to leave their residuary estates to each other. This gift will be free of inheritance tax. However, there are some situations in which an unmarried person may benefit from including a nil rate band trust in their Will. For example, if the residuary estate is being passed to charity (which will not attract any inheritance tax), the testator’s nil rate band will be wasted. By including a nil rate band trust, the testator can carve out the tax-free allowance and pass it to beneficiaries who are not exempt from inheritance tax.