What is the Nil Rate Band and how does it affect Inheritance Tax?

According to Benjamin Franklin, there are two certainties in life; death and taxes. However, one eventuality that Mr Franklin most likely did not prepare for is the notion of a tax on death. In the United Kingdom, Inheritance Tax is an issue that haunts many families each year and has done since its formal introduction in 1984. The Inheritance Tax charge is entirely dependent upon the value of the net estate on death. When the calculation is made, it takes into account everything you own wherever situated, including any property, money, personal chattels all over the world.

As it stands the first £325,000 (known as the Nil Rate Band) of your estate assets can be transferred Inheritance Tax free to your heirs, unless you pass everything to a spouse, charity or civil partner, in which case the tax is nearly always nil. However, if your children or non-exempt persons (anyone who isn’t your wife, civil partner or charity) are the beneficiaries of the estate, everything in excess of the Nil Rate Band is taxed at a rate of 40%.

For example, Oliver has an estate of £400,000 on his death who he bequeathed to his friend, Dan. After deducting the Nil Rate Band of £325,000, Oliver’s estate is left with a taxable estate of £75,000, which is then taxed at 40% and brings a total tax bill of £30,000. It is important to note that it is not the entire estate which is taxed at 40%, it is only the amount which exceeds the available Nil Rate Band.

If in your will you decided to bequeath 10% of your net estate to a registered charitable organisation, then you would only be charged at 36% rather than the normal 40%.

There are some ways that you can protect your estate from tax, but they are not without risk. You can make life time gifts (known as Potentially Exempt Transfers), which if they are made over 7 years before the date of your death will be removed from your estate when calculating the Inheritance Tax. If you were to adopt this method of gifting away assets and hoping you live seven years, you must not withhold a benefit in order to have them removed from your estate. The most common example is gifting the family home to your children and then continue to reside in it until your passing. As you withheld a benefit of residence, the property is never out of your estate and the seven-year clock never begins. Furthering this, if you die before the 7 years is complete, then the gifts may become part of your estate and fall into the calculation for IHT.

If you are married, then you can transfer your assets to your spouse or civil partner in life tax free whether that’s in lifetime or on death. This was famously done by Bruce Forsythe who transferred an estimated £11,700,000 to his wife free of Inheritance Tax by taking advantage of the spousal exemption rule. If this is the case and all assets were transferred to the spouse through the will or intestacy, the second spouses’ estate would also then benefit from a transferable Nil Rate Band from the first spouse’s estate, which can only come into effect upon the second spouse’s death. Introduce in 2007, the personal representatives of the estate are able to transfer the unused proportion of the Nil Rate Band to the second spouse’s estate from the first spouses’ to offset against any potential IHT charge.

This could essentially double your Nil Rate Band to £650,000 on the second death, meaning that if you had an estate valued at £700,000 only £50,000 would be eligible for Inheritance tax. Without the transferable Nil Rate Band £375,000 would be taxable and the inheritance tax from that amount would be tripled to £150,000.

Furthermore, since 6th April 2017, estates can now benefit from the Residence Nil Rate Band for qualifying residential property which passes to lineal descendants on death. The current rate of the RNRB is £125,000 and is due to increase to a maximum of £175,000 in the tax year of 2020/2021. Fortunately, the RNRB is capable of being transferred on the same principle as the NRB in the hope that in 2021, couple will be able to benefit from both the Transferable Nil Rate Band and Residence Nil Rate Band and passing up to £1,000,000 to their heirs free of Inheritance Tax.

You can bypass the Nil Rate Band through some trusts such as a Pilot Trust or a Bereaved Minors Trust but to qualify for these trusts you need to meet certain criteria and there are other tax implications that can occur.

For more information on the subject or to understand trusts in greater detail, please call the SWW Trust Corporation on 01522 581 570 for a confidential chat

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