Understanding the residence nil-rate band

Inheritance tax can often be the elephant in the room. Most of us don’t really want to talk about what will happen after our deaths; but the reality is that if we don’t, the beneficiaries of our wills may end up with less than we had intended.

Indeed, far from being solely targeted at the ‘wealthy’, more and more families are now paying inheritance tax. But with some careful planning, a variety of tax reliefs and allowances can be used to help you pass on as much as possible to your loved ones.

What a (tax) relief

One of the latest additions to the armoury of inheritance tax (IHT) reliefs and allowances is the ‘main residence nil-rate band’ (RNRB). Announced in the government’s Summer Budget of 2015, this measure was brought in last year and is designed to boost the IHT-free allowance of individuals with estates that include a main residence.

Operating in addition to the existing ‘nil-rate band’ (NRB), which allows individuals to pass on up to £325,000 of their estate upon death tax-free to anyone they wish, this new RNRB allowance specifically relates to the main residence that’s included in the estate (and not to any buy-to-let properties).

“Up to £125,000 of the net value of your home can now be passed on IHT-free thanks to RNRB – provided the property is left to your direct descendants (such as children, step-children, foster children or adopted children, their lineal descendants, and their spouses/civil partners),” says Ben Hewitt, Chartered Financial Planner at Alan Boswell Group.

“Even better,” he adds, “the RNRB will rise to £150,000 next tax year, and then to £175,000 in 2020,” at which point the government will have achieved its manifesto promise of a £1 million IHT-free allowance per couple [i.e. £325,000 NRB per person, plus £175,000 RNRB per person]. After 2021, the RNRB is set to increase in line with the Consumer Prices Index.

Attention to detail

Many people in the UK will find that these IHT allowances will provide an entirely tax-free inheritance for their loved ones; but those with high-value estates are unlikely to benefit much – if at all – from the RNRB.

Under current rules, if the net value of an estate (after deducting any liabilities, but before reliefs and exemptions) exceeds £2 million, then the additional nil-rate band will be tapered away by £1 for every £2 above that threshold amount. An estate worth £2.25 million or more during this tax year would therefore not be eligible for any RNRB allowance at all.

But there are also some pros to be found in the finer details. “For example, the additional nil-rate band even applies when a person downsizes or ceases to own a home – perhaps selling up in order to move into residential care,” says Ben. In such situations, assets of an equivalent value, up to the value of the RNRB, can be passed to the individual’s direct descendants.

The additional nil-rate band even applies when a person downsizes or ceases to own a home

If you’re married or in a civil partnership then you can already leave your entire estate to your surviving spouse or civil partner tax-free, but the good news doesn’t end there – any RNRB and/or NRB allowance that you didn’t use can also be transferred to him or her. (Unless, in the case of RNRB, you don’t qualify for it, due to the high value of your estate – see above.)

So, say you pass on your whole estate to your husband or wife on your death. You won’t need to use any of your IHT-free allowance because gifts to spouses are automatically tax-exempt, so your unused NRB (£325,000) and RNRB (£125,000, assuming no tapering is applied) can then be transferred to him or her. Once added onto your spouse’s own IHT-free allowances, s/he will in turn be able to pass on up to £650,000 of your combined estate to any friend or family member, and up to £250,000 of the net value of your family home to your children – all completely tax-free.

“Broadly speaking, most people who leave everything to their spouse or civil partner on first death and to their children on second death will be in the best position – they’ll qualify for combined relief on the whole lot,” says Ben. “But things are often much more complicated than that – especially if you have a substantial estate or want your will to name beneficiaries that are not direct descendants. That’s why it’s important to seek professional advice in regard to your IHT planning.”

Read more: Business Property Relief: Planning for the future

Solid estate planning strategies

With a whopping 40% IHT rate applied to estate values that exceed the nil-rate bands (after deducting any applicable reliefs or exemptions), it’s imperative that any potential tax bills are identified and minimised before they can impact on your beneficiaries.

“If you’re unsure of your position, then you need to get your will looked at by your solicitor,” Ben urges. “If your solicitor says you’ve done everything you can but there’s still an IHT bill, then an experienced, independent financial adviser can work with you to reduce that potential bill. The longer we have to do so, the better; and since none of us know our date of death we should see this as an urgent objective.”

Luckily, there are lots of routes that can be taken to legally minimise – or even avoid – inheritance tax. For example, during your life you can gift up to £3,000 each tax year, meaning a couple can give away £6,000 between them. You can also give as many small gifts of up to £250 as you wish, tax-free, to whoever you like (except the persons to whom you made a gift of £3,000); and certain amounts can be given as wedding gifts to children and grandchildren without incurring any IHT.

Read more: 5 things you need to know about Inheritance Tax

“The next stage, if you’ve still got an IHT bill, is to gift money away via ‘potentially exempt transfers’ (PETs),” Ben adds. “Through these, you can give as much as you like to whoever you wish, but you need to survive that gift by seven years.

“Alternatively, if you want to maintain control of your full estate for a little longer, there are other ways to mitigate IHT – by buying life insurance, for instance, or investing money in businesses so as to qualify for business relief. These are all things that can be discussed in more detail with your financial adviser if necessary.”

If you want to maintain control of your full estate for a little longer, there are other ways to mitigate IHT

Ultimately, then, the RNRB is there, along with the NRB, to help individuals pass on more of their estate tax-free upon death. But its introduction is also a reminder to us all that regular reviews of our end-of-life plans are essential to make full use of all available reliefs and allowances – and, importantly, to keep IHT bills as low as possible.

Please note, the value of an investment and any income from it can go down as well as up and you might not get back the original amount invested. The past is not a guide to the future. The value of tax benefits depends on your individual circumstances and the laws concerning these can change.