Inheritance Tax – How To Make The Most Of Your Tax-Free Allowance

The Residence Nil Rate Band system was introduced to the UK in 2017 and was phased in over four tax years. The roll-out of the system was designed to help people who wished to leave their family home to their loved ones and reduced the inheritance tax that their estate was obligated to pay.

Below, we have outlined the Residence Nil Rate Band system and how you can prepare your Will to make the most of this tax-free allowance.

What is the Residence Nil Rate Band?

Inheritance tax is charged on the value of your estate – which includes your property and possessions, savings and investments, life policies, business interests and assets held abroad – when you die. Where you own assets jointly, the value of your share in these is included.

The inheritance tax threshold for an individual is set at £325,000, which is also known as the Nil Rate Band. No tax is payable on the value of a person’s estate up to this threshold, however, the value of an estate over this threshold is currently taxed at the rate of 40%.

For any deaths that have occurred since 6^th April 2017, executors may have been eligible to claim an additional inheritance tax threshold known as the Residence Nil Rate Band. In general terms, the Residence Nil Rate Band is available where the deceased leaves a residence – a property that has been occupied by the deceased – directly to lineal descendants (children, grandchildren, adopted children, stepchildren and foster children).

How much is the Residence Nil Rate Band?

The amount of this allowance depends on the date of death and is limited to the value of the deceased’s interest in a single property. For deaths that occurred in the tax year 2017/18, the Residence Nil Rate Band started at £100,000. The threshold has increased incrementally since then (£125,000 in 2018/19 and £150,000 in 2019/20) and for deaths that occurred in the tax year 2020/21 and after, the amount is now £175,000 (in the Budget 2021, it was confirmed that the inheritance tax at 2020/21 level would remain the same up to and including 2025/26).

When combined with the Nil Rate Band, this can be a valuable relief. For deaths now, the maximum total tax-free allowance for an individual is £500,000 – that’s £325,000, plus £175,000 additional residence allowance. For a married couple with children, they will be able to pass on £1 million in total – two lots of £325,000 (£650,000) and two lots of £175,000 (£350,000).

How do I qualify for the allowance?

To qualify for the allowance, lineal descendants must inherit directly. Be aware that the existence of a Trust may prevent direct inheritance, therefore, any arrangement where a descendant does not inherit immediately should be considered carefully.

For example, Mr and Mrs Smith’s estate totals £950,000, which includes their £300,000 home. The couple leaves their entire estate to their two grandchildren, with the Will stating that they shouldn’t receive their inheritance until they are 30 years old.

The value of the estate – excluding Mr and Mrs Smith’s home – is worth £650,000, therefore, not exceeding the inheritance tax threshold for them both. However, because the grandchildren’s inheritance has been deferred, a Trust has been created and they do not inherit the property outright.

This means that the Residence Nil Rate Band cannot be claimed, and inheritance tax will be payable in respect of the value of the property. Of course, some families may prefer to defer the age that the beneficiaries can receive their inheritance because they do not consider them to be mature enough. However, it’s important that they understand the tax consequences of this.

What do I need to do?

We recommend that you dust off your old Wills to make sure they still reflect your wishes and to ensure that, where possible, you make the most of any available inheritance tax allowances.

It is important that you review your Will, especially if you have prepared Wills that leave assets in a Trust, such as a Nil Rate Band Discretionary Trust. These types of Will Trusts were commonly made before the introduction of the transferable Nil Rate Band between spouses.