Inheritance tax – a guide

Inheritance Tax may be charged on an estate when an individual dies. It may also be payable on trusts and gifts made by an individual during their lifetime. In the UK, an individual has a tax-free allowance of £325,000 otherwise known as the Nil Rate Band.

In 2017, a new tax-free allowance was introduced for individuals who own a house and leave it to their descendants. This new allowance is known as the Residential Nil Rate Band. In the current tax year 2022-2023 the Residential Nil Rate Band is £175,000.

The current rate of inheritance tax is 40% and is paid on the value of the estate that is over the Nil Rate Band and the Residential Nil Rate Band. For example, Jack has a net estate of £550,000. Assuming he has made no lifetime gifts or created any trusts he will have the full Nil Rate Band of £325,000 and the Residential Nil Rate Band of £175,000 (if he is leaving his property to his decedents-see below). He therefore has a total tax-free allowance of £500,000. Inheritance Tax is payable on the £50,000 that is over the tax-free allowance. Tax would be payable at £20,000.

Tax rules can change, and this guide only covers the new rules that were introduced in 2007 and 2017.

Exemptions and reliefs

There are a number of exemptions available to individuals including:

1. Gifts to current Spouses and Civil Partners are exempt.
2. Gifts of up to £250 each tax year to any individual are exempt. There is no limit on the number of individuals to whom such gifts can be made.
3. Annual exemption of £3,000 each tax year. If this exemption is unused in one year it may be carried forward to the next tax year.
4. Gifts to charities and certain national bodies are also exempt.
5. Gifts in consideration of marriage - gifts up to £1,000 to any individual who is getting married are exempt. Grandparents may give £2,500 to either party and parents may give £5,000 to either party.
6. Disposition for maintenance of family - payments may also be made for the maintenance of any dependant family member provided certain qualifying conditions apply.
7. Normal expenditure out of income - payments out of surplus income in any tax year may be exempt but sufficient income should be retained by the donor to maintain their standard of living. To claim this exemption, you should aim to establish a regular pattern of giving.
8. Potentially exempt transfers - gifts to individuals and to trusts for the disabled are exempt provided the donor survives seven years from the date of the gift.

In addition to the above exemptions there are other reliefs available such as Business Property Relief and Agricultural Property Relief. There are strict rules relating to the applications of these reliefs and we strongly recommend speaking to a member of our team if you feel your estate could qualify for either.

For estate planning purposes, it is important to keep detailed records of lifetime gifts, gifts out of income and any unused tax allowances on the death of a first spouse.

Transferable Nil Rate Band

Prior to 2007 a married couple could not leave their unused Nil Rate Band to their spouse. An individual had to use it on their death or lose it. In 2007 changes in the law allowed married couples to give their unused Nil Rate Band to their surviving spouse. This meant that upon the second death, a surviving spouse could have a double Nil Rate Band of £650,000. This was highly beneficial for married couples and removed the need for creating Nil Rate Band trusts in their wills, which were popular pre-2007.

The Residential Nil Rate Band

The Residential Nil Rate Band is also transferable to a surviving spouse/civil partner if they own a property and are leaving it to their descendants. Descendants would include your children, stepchildren, grandchildren and foster children. In this year’s current tax year (2022-2023) a married couple potentially have a total tax-free allowance of £1,000,000 on the second death.

The Residential Nil Rate Band can be claimed in full if your estate is less than £2 million. If your estate is over £2 million, then then the Residential Nil Rate Band begins to taper. But once your estate reaches £2.3 million the relief is not applicable.

In order to claim this allowance your property must be inherited by your direct descendants absolutely. Therefore, you cannot stipulate an age contingency in the will, for example 21 years.

For this reason, you may wish to review the terms of your will in order to obtain this additional allowance.

How we can help

If you would like to discuss any of the above or review your current will please get in touch with one of our team who can advise. Our services range in price depending on your circumstances and we will be able to provide you with a cost estimate after the initial meeting.