Inheritance tax: nil rate band and Residence Nil Rate Band

Inheritance tax

I outline the basic Inheritance Tax allowance (nil rate band) and the newer Residence Nil Rate Band below.

Nil rate band

Inheritance tax on your assets is charged at the following rates:

  • 0% for the first £325,000 (known as the nil rate band)
  • 40% on the balance.

If 10% of your net estate is left to charity, the 40% rate is reduced to 36%. You can use this handy calculator to see if an estate qualifies for this reduction.

The nil rate band will remain at £325,000 until April 2021 (Section 10 Finance (No 2) Act 2015) although given the financial impact of the pandemic, it seems unlikely that the Chancellor will offer anything more generous at this stage.

Residence nil rate band

In addition to the nil rate band, an additional allowance – the Residence Nil Rate Band – has been introduced by ss 8D–8M of the Inheritance Tax Act 1984. For the 2020/21 tax year, this was £175,000. Unfortunately this allowance is rather complicated and subject to a lot of rules.

Broadly speaking, the allowance can be claimed by a Deceased person’s estate where:

  • The Deceased owns a property or an interest in a property, which at some point was their home; and
  • This is passed on to a lineal descendant (for example, a child)

Where an estate is valued at £2 million or more, there is a tapered reduction of the Residence Nil Rate Band of £1 for every £2 over the £2 million threshold.

Transferrable allowances

If a couple are married or in a civil partnership, both of the above nil rate bands are transferable. This means that if the first-to-die’s estate does not use all of the allowance, the second-to-die’s estate can claim a percentage uplift in their allowances.

If something is left to your spouse or civil partner on death, it is known as ‘spouse exempt’. It does not use up your Inheritance Tax allowances.

Example:

Alan and Sam are married. They have one child, Alice. They own a house worth £750,000 and investments of £250,000.
Alan dies, leaving everything to Sam. This means that none of Alan’s nil rate bands have been used.Sam dies, leaving everything to their child, Alice. His estate can claim:

  • Sam’s £325,000 nil rate band
  • Sam’s £175,000 Residence Nil Rate Band
  • 100% uplift on both allowances, because Alan’s estate did not use his nil rate band. Everything was left to Sam and was therefore ‘spouse exempt’

Sam’s estate therefore benefits from £1 million Inheritance Tax allowances and is not liable for any Inheritance Tax. Alice takes £1 million.

You will note that above, the first-to-die Alan does not leave his share of the family home to a lineal descendant. This does not waste the Residence Nil Rate Band because Alan’s unused allowance is later claimed by his spouse’s estate.

Note also that for larger estates worth more than £2 million at the time of the first death, the percentage uplift that the survivor’s estate can claim will be reduced or eliminated because of the taper mentioned above.

One very important point to note about the above example is that, whilst it is a common arrangement, it is NOT the ideal arrangement for inheriting property by far. If the survivor:

  • Goes into care
  • Falls into debt or bankruptcy
  • Remarries

the entire estate could be lost to care fees, creditors or a new spouse. The children may never inherit.

Fortunately there are ways to protect a substantial part of the estate from such threats, without losing the generous Residence Nil Rate Band. A Will trust can be used so that the survivor gets a ‘life interest’ in the first-to-die’s share of the property, rather than inheriting outright. This protects a substantial part of the estate for the children.

Leaving money to minors

If the children are minors when both parents die, they will not be able to inherit the property outright. However, provided that their inheritance is left in the right type of trust, the Residence Nil Rate Band will still be available. Trusts that qualify include:

  • an immediate post-death interest (Section 49 Inheritance Tax Act 1984)
  • a disabled person’s interest (Section 89/89B Inheritance Tax Act 1984)
  • bereaved minor’s or bereaved young person’s interests (Section 71A/71D Inheritance Tax Act 1984)

A bare trust would also qualify but it is unlikely parents would choose this over the other options, as the child is entitled to the property in the trust when they reach 16. Property in a discretionary trust will not qualify for the allowance, even if all the beneficiaries are lineal descendants. Neither will a trust that specifies, for example, ‘to such of my children as reach 21’.

If the parent has drawn up a Will that includes a discretionary trust, an appointment can be made from the trust within 2 years of the death to take advantage of the Residence Nil Rate Band. ‘Appointment’ simply means taking the property out of the trust and giving it to a lineal descendant. This is treated as if the Deceased themselves made the appointment – it is ‘read back into the Will’ (Section 144 Inheritance Tax Act 1984).

However, where the Wills first include a life interest and then a discretionary trust, it will often not be possible to make such an appointment in respect of the first-to-die’s share, since this is not inherited by the beneficiaries until the survivor dies. It is therefore safer not to use a discretionary trust!

Options for grandparents

Some of the above types of trust are not available to grandparents. If they want to leave property to a minor, their options are bare trusts, Immediate Post-Death interests and Discretionary Trusts. Each has their own advantages and disadvantages, particularly when it comes to tax!

Downsizing allowance

If an elderly person downsizes, their estate will usually be able to claim the full amount of Residence Nil Rate Band that they would have been entitled to, had they not downsized. This was to prevent elderly people clinging on to unsuitable houses just to claim the allowance.

A final note

The Residence Nil Rate Band may all sound rather complicated – because it is! One of the best guides to the Residence Nil Rate Band allowance was produced by Charles Holbech and it spans an impressive 75 pages. It is best to seek the advice of an experienced estate planning solicitor to ensure your property fully benefits from all of the available allowances.

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