Understanding the Nil Rate Band

The nil rate band may have come up throughout your estate planning process, or perhaps this is the first time you’ve heard of it. Either way, understanding it is essential when writing your Will and deciding what to do with your assets, as it can greatly impact what you can leave to your loved ones. 

What Is the Nil Rate Band?

Simply put, the nil rate band is the amount you can leave to your beneficiaries without needing to pay Inheritance Tax (IHT). Currently, the band sits at £325,000 and is fixed at that rate until 2026. It takes into account everything in your estate that you may leave to your loved ones, which consists of the following:

  • Your sole estate on death – assets including property, bank accounts, shares, investments, and personal belongings. This also includes assets held within trusts that you benefitted from. 
  • Gifts or Chargeable Lifetime Transfers – any gifts or transfers that you make within seven years before death. For example, if you paid £10,000 into a trust five years before you passed away, the nil rate band would take this into account, and £315,000 would be left against the remainder of your estate. 

However, the nil rate band is more complex than this. If you make gifts before you pass away, your nil rate band could be decreased, as gifts are counted within your estate unless seven years have elapsed since you created them. 

You can also stack your nil rate band with that of your spouse. Even if your spouse passed away several years ago, you could use it to pass on up to £650,000 of your assets IHT-free if they did not use their nil rate band.

Gifts and Inheritance Tax

Giving gifts can affect how much of the nil rate band you can use in the future. However, they can also lower the amount of IHT you pay and increase the sum you can give tax-free. 

You have an annual gift allowance of £3,000 annually, which carries over into the following year if unused. This allows you to give a maximum of £6,000 per year, completely tax-free. However, it only carries forward one year. 

Other tax-free gifts include:

  • Wedding gifts – for IHT purposes, gifts have to be given before the wedding, and the marriage must go ahead for them to be counted. For children, you can provide a maximum of £5,000, and for a child or great-grandchild, you can give up to £2,500. To anyone else, you can gift up to £1,000. 
  • Gifts up to £250 – you can give as many gifts as you like up to the value of £250. However, you can’t give these gifts to anyone who has received a donation of your entire £3,000 gift allowance. 
  • Gifts from surplus income – if you have enough income to maintain your standard of living, you can make gifts from your surplus income, such as paying into a savings account for a child or grandchild. These gifts must be regular, and it is important to keep a good record of these gifts otherwise, IHT might be applicable. 
  • Charity gifts – gifts to charity, museums, or universities are exempt from IHT. If you leave 10% of your estate to charity in your Will, the rate of IHT is lowered to 36% instead of 40%. 

Potentially exempt transfers (PET) can also be IHT-free, but they come with a few conditions. You can give any amount of money, but if you die within seven years, IHT will be due. However, if the gift was given over three years but seven years before death, taper relief applies, and the IHT due can be lowered:

  • 3-4 years – 32%
  • 4-5 years – 24%
  • 5-6 years – 16%
  • 6-7 years – 8%

What Is the Residence Nil Rate Band?

The residence nil rate band (RNRB) was introduced in 2017 and increased the amount you can pass on IHT-free against the value of your family home. It is currently fixed at £175,000, so you can pass on up to £500,000 tax-free when combined with the nil rate band. The RNRB can also be stacked and combined with your spouse’s nil rate band allowance so that you could pass on £1 million tax-free. 

Only one home can utilise the RNRB. If you own multiple properties, it is up to you to choose which one should qualify, although it must be a residence (buy-to-let properties will not be able to use the allowance). 

There are, however, some caveats to being able to use the RNRB. Firstly, you must pass your property onto direct descendants such as children or grandchildren (foster children or step-children also count as direct descendants), but you cannot give it to a niece or nephew. Trusts can also negate the RNRB, especially discretionary trusts commonly placed in Wills. Some forms of trusts can be used while still utilising the RNRB, such as giving a child or grandchild absolute interest or interest in possession. However, this is complex, so contact The Planning Bee to see which ones are right. 

It is also important to remember that the RNRB tapers for larger estates. For every £2 your estate is valued over £2 million, the residence nil rate band is reduced by £1. Therefore, if your estate exceeds £2.35 million (or £2.7 million if you bring your spouse’s allowance forward), the RNRB will be cancelled. The rules around this tapering are complex, and HMRC can calculate your tax slightly differently. Consult with The Planning Bee to learn more about how the RNRB affects your estate and how you can get the most out of it. 

The residence nil rate band maximises how much you can leave to your loved ones without it being taken by IHT. This, too, can be unclear, so professional estate planning is necessary. At The Planning Bee, we will work with you to find the best estate planning solution for your individual needs so you can leave more to your loved ones free from stress.

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