By Alex Morrissey
Inheritance Tax (IHT) is often an overlooked area of people’s financial plans. It is not always for those with significant assets and can creep up on you over time.
Property, business interests, savings and investments can quickly push an estate well beyond the standard allowances, leaving families exposed to a substantial tax liability.
Without careful planning, as much as 40% of your net estate could be lost to tax, impacting the wealth you’ve worked hard to build and the legacy you want to leave behind.
What are your allowances?
First, you need to understand what is available to you. The common misconception is that you simply have £1 million as a couple, but how is that made up?
Residence Nil Rate Band (RNRB). This allowance applies when passing on a main residence to direct descendants, such as children or grandchildren. Currently, it provides up to £175,000 per individual, or £350,000 for a couple when combined.
The RNRB can only be applied to your main residence, and if the property is worth less than the available allowance, the unused portion cannot be applied to other assets meaning it is effectively lost.
For larger estates exceeding £2 million, the allowance begins to taper away. For every £2 your estate exceeds this threshold, £1 of the RNRB is lost, eventually removing the allowance altogether.
Nil Rate Band (NRB). This is the portion of an individual’s estate that can be passed on free of inheritance tax on death, currently £325,000 per person. However, this allowance may be reduced if it has already been used by certain lifetime gifts.
Succession of allowances
It is very unlikely that both individuals in a couple will die at the same time. In most cases, on the first death, the entire estate passes to the surviving spouse or civil partner. This transfer is typically exempt from inheritance tax due to the spousal exemption.
Where everything passes to the surviving spouse or civil partner, it is likely none of the deceased’s inheritance tax allowances will have been used on first death. As a result, the unused allowances can be transferred to the survivor and applied on the second death.
This means that on the second death, the estate may benefit from:
- The deceased’s own Nil Rate Band (NRB)
- Any unused percentage of their spouse or civil partner’s NRB
- The Residence Nil Rate Band (RNRB), if applicable
- Any unused percentage of their spouse or civil partner’s RNRB
In effect, this can allow a couple to combine their allowances, potentially doubling the amount that can be passed on free of inheritance tax, provided the relevant conditions are met and the allowances are claimed correctly by the executors.
In effect, this can allow a couple to combine their allowances, potentially doubling the amount that can be passed on free of inheritance tax, this is where the commonly referenced £1 million figure comes from.
Hidden Traps
I have already alluded to one which is the loss of your Residence Nil Rate Band (RNRB) where the estate is over £2m, but there are a couple more common pitfalls:
- Pensions – From 5 April 2027 Pensions are set to be included in your estate for Inheritance Tax. This, for money, has been the biggest changes in decades, and has taken those without a liability, well above their allowances.
- Gifts – Where you have made lump sum gifts above your annual £3,000 allowance, these could impact your allowances on death. If made in the last 7 years, these gifts might use up some or all of your Nil Rate Band (NRB) and might even be subject to tax themselves. Furthermore, where trusts are involved, gifts up to 14 years ago might impact you on death.
- Who you leave your main residence to – If you have no children, or don’t plan to leave them or grandchildren your home, then you would be unlikely to benefit from the Residential Nil Rate Band. This is also the case if you leave your main residence to a Discretionary trust, even if your children are the beneficiaries.
Inheritance tax can be complex, but our Financial Planners can help ensure you make the right decisions to only pay what you need to.
This article is based on current legislation. In particular, Pensions have been confirmed to be included in estates for IHT from 5 April 2027, however this is subject to legislative change.
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