13/01/26
When a death occurs, the deceased’s estate is assessed for a type of tax known as Inheritance Tax (‘IHT’). This tax is commonly referred to as the “death tax” but there are other instances where IHT can be triggered aside from on death which will be briefly touched upon later in this article.
The legal framework that establishes the rules for the assessment and payment of IHT is set out in the Inheritance Tax Act 1984 (‘IHTA 1984’).
Everyone who is classed as a “long-term UK resident” (formerly known as UK domicile) will pay UK IHT on their worldwide assets. Those who do not fall into this category will only have their UK assets fall within the scope of UK IHT.
IHT Allowances
Nil Rate Band (‘NRB’)
Each individual, regardless of whether they are a long-term UK resident or not, will be entitled to an IHT allowance known as the NRB. Currently the NRB is a maximum of £325,000 and this threshold has been frozen until April 2030. If a death occurs and the deceased’s estate value falls within their available NRB, IHT will not be payable. Sometimes the NRB is referred to as a tax-free allowance, although technically the NRB isn’t tax free but carries with it a tax rate of 0%.
The NRB isn’t just applicable for transfers on death; the NRB can also apply when it comes to lifetime gifts such as transfers into trust (Chargeable Lifetime Transfers) or failed transfers to other individuals (Potentially Exempt Transfers).
With Chargeable Lifetime Transfers the NRB is utilised straight away, and if more than the available NRB is transferred to trust within a 7-year period, then a charge to IHT will be triggered on the excess value.
Whereas with Potentially Exempt Transfers, IHT is only triggered if the donor does not survive the 7-year period following death and the amount gifted exceeds the NRB.
As a result, there may be instances where a deceased’s estate value falls within the £325,000 threshold, but the deceased’s NRB had already been used on gifts made within 7 years of death resulting in IHT being payable on the estate.
One of the responsibilities of the executors is to establish how much of the NRB is available to the estate so the IHT position can be known.
Residence Nil Rate Band (‘RNRB’)
In 2017 an additional IHT allowance was introduced called the RNRB. The maximum amount that can be claimed is up to £175,000 or capped at the value of the property being used for the claim if the value is lower. The RNRB threshold has also been frozen until April 2030.
Unlike the NRB, not everyone is entitled to an RNRB allowance. The IHTA 1984 details who is entitled to the allowance and how much allowance can be claimed based on the circumstances of the individual estate.
There is set criterion that need to be satisfied in order to make the claim and broadly they are detailed below:
- The estate comprises of a property (or share thereof) that had been occupied by the deceased at some point during their ownership period;
- The deceased was survived by at least 1 lineal descendant (e.g., a child, grandchild etc); and
- The property (of share) was closely inherited by a lineal descendant (either outright or via a qualifying trust).
This criterion does narrow the pool of entitled estates, particularly if the deceased did not have children or their will directs their property to non-lineal descendants.
There are also exceptions and considerations to the rules established above that can broaden or restrict those who may or may not have been entitled to the allowance.
Downsizing
If the deceased ceased to own a property either through gifting or sale on or after the 8th July 2015, and the rest of their estate is closely inherited by a lineal descendant, their executor may still make a claim for the RNRB. The amount that can be claimed can only be the value that could have been claimed if the property had remained a part of the estate on death.
Example 1:
Mr Smith owned his main home worth £100k. In August 2018, he sold his home and moved in with his daughter. Mr Smith died in May 2020, and his estate comprised of only cash worth £425k.
Mr Smith’s Will left his entire estate to his daughter who was also his executor. Mr Smith’s estate was entitled to his full NRB of £325k. But when assessing how much RNRB could be claimed by the estate, his daughter had to consider how much RNRB could have been claimed if he had not sold his property.
The value of his property was £100k so the maximum amount of RNRB would have been capped at £100k. Therefore, the estate could only claim an RNRB allowance of £100k.
Conversely, if the deceased downsized after the 8th July 2015 from a higher value property to a lower value property, then the executors may claim under the downsizing provision a higher amount of RNRB based on the value of the former home.
Example 2:
Mr Smith owned his main home worth £130k. In August 2018 he sold his home and purchased a flat worth £100k. In May 2020, Mr Smith died and his estate comprised of savings worth £350k and his flat of £100k.
Mr Smith’s Will left his entire estate to his daughter who was also his executor. Mr Smith’s estate was entitled to his full NRB of £325k. His daughter assessed how much RNRB the estate could claim, and since Mr Smith had downsized after the 8th July 2015, his former home value of £130k could be used rather than his flat value of £100k. This meant Mr Smiths’s estate could claim £455k of IHT allowances rather than £425k resulting in no IHT being payable.
For married couples or couples in a registered Civil Partnership, the maximum amount that they can claim in terms of IHT allowances is up to £1 million. These allowances can be transferred between spouses/civil partners on death if they are unused. For example, if first death occurs and their estate was within their NRB, then their unused RNRB can be claimed by the surviving spouse on their death as an unused transferrable allowance.
However, the value of the estate has to be considered as the RNRB is only available to estates under £2.35 million.
The RNRB Taper
Under the IHTA 1984, if the value of an estate exceeds £2 million, the amount of available RNRB allowance will begin to taper by £1 for every £2 that the estate is over the £2 million threshold. Therefore, if an estate value reaches £2.35 million, the full £175k allowance would be tapered completely.
This can be a concern for estates that are of significant value, particularly if they comprise of IHT-free assets such as agricultural or business relievable assets. There is also a concern where wills are written to leave the entire estate to the survivor on death as the surviving spouse’s estate is often doubled in value after first death, placing the survivor at higher risk of reaching the £2 million taper threshold.
IHT Exemptions
Spousal Exemption
Transfers on death (also in lifetime) to a spouse or registered civil partner will be exempt from IHT under spousal exemption rules, as per s.18 IHTA 1984. This also applies to transfers between non-long-term residents for the purposes of UK IHT.
There is special consideration for transfers between a long-term UK resident and a non-long-term UK resident and the maximum amount that can be claimed by the UK long-term UK resident is the maximum of £325,000. It is advisable for these clients to seek advice and careful restructuring of their wills may be required.
Charitable Exemption
Similarly to transfers between spouses and civil partners, transfers to a UK qualifying charity will benefit from an exemption from UK IHT as under s.23 IHTA 1984.
This exemption can be useful if an individual wishes to leave part of their estate to charity and the amount being gifted reduces the taxable estate to the value of the IHT allowances.
Reduced Rate of IHT
If on death at least 10% of the net chargeable estate is left to a qualifying charity, the estate can claim a reduced rate of IHT. The rate is reduced from 40% to 36% for the value of estate that exceeds the IHT allowances.
However, to claim this reduction it isn’t as simple as stating that 10% of the estate is to go to charity. There is a calculation that has to be done to assess whether this is available. HMRC have a calculator that can be used but of course there could be changes in the estate which could affect this calculation.
The Legacy Software has an option under ‘Legacies’ that allows the client to implement a 10% charity clause which bequeaths 10% of the net chargeable estate and includes the calculation which acts as a failsafe should the estate change in value.
Conclusion
As this article has shown, the IHT position of an estate is the result of a combination of lifetime gifting, ownership of assets, legislative changes and the way a client’s planning has been structured. The availability of the allowances and reliefs covered is dependent on satisfying strict conditions and what might seem like insignificant changes in circumstances can have significant implications for IHT.
Incorrect or incomplete planning can result in allowances being lost entirely, estates falling unexpectedly within the scope of IHT, or beneficiaries receiving substantially less than intended. This is particularly relevant given the frozen thresholds and the increasing property values. Without careful consideration, even estates comprising largely of IHT-exempt assets may trigger a higher tax liability on second death.
It is therefore evident that careful structuring of a client’s death planning is crucial. The Estate Planning Team offer a range of supportive tools and are available to provide guidance when it comes to your client’s estate planning.
Written By