£1Million Tax-Free

Although Inheritance Tax (IHT) is paid out on any money over £325,000 in your estate, there is a range of fully legal methods to boost the amount you can pass on to your loved ones without paying any tax on it.

How it works.

Your estate refers to all your assets, including property and interests in possession trusts, after debts are deducted. You have an allowance of £325k. This is referred to as the Nil Rate Band (NRB). If your estate is less than this, there is no IHT to pay; anything over is taxed at 40%. 

For example, Carl and Eve lived together as common-law husband and wife for 25 years. Carl's cash, cars, and business were worth £500k. If Carl died without a Will but told Eve that she would get everything, she would actually get nothing. This is because a common-law wife/husband is a myth and is not legally recognised, and verbal promises do not constitute a legal Will.

Suppose Carl had a legally valid Will and left everything to Eve, his £500k less the allowance of £325k = £175k. Taxed at 40% = £70k IHT. Eve would have to pay the £70k within six months or face 7.5% interest on any unpaid amount.

Marriage and Civil Partnership.

Most people don't realise that what you leave to your husband or wife is tax-free. There must have been a legal ceremony. Cohabiting as a common-law husband and wife, or husband and husband, or wife and wife, doesn't count. 

Eve would have been £70k better off if they had been married.

Married with Children

You gain an extra IHT allowance of £175k if you pass on your primary residence to your children. This is the Residence Nil Rate Band (RNRB).

The NRB £325, plus the RNRB £175k = £500k potential allowance.

Finally, you can transfer (Transferable Nil Rate Bands) ALL of your unused allowance to your spouse. So, if you left them everything, they could leave £1M, including a house, with no tax. Your £325k, plus £ 175k, including a home, would then be doubled by adding your and their Inheritance Tax allowances together. That means if you follow each of those rules, you pass on a house to your spouse as part of a £500,000 estate, and then your spouse passes it on again when they die, you'll have successfully passed down £1 million with no Inheritance Tax. If you do happen to exceed those thresholds, you will be charged 40% of the amount over the allowances at the time of the charge. So if you were £50,000 over the limit, you would pay 40% of £50k = £20,000 in IHT.

Who is a direct descendant

For residence nil rate band RNRB purposes, the direct descendant is:

• a child, grandchild or other lineal descendant
• a spouse or civil partner of a lineal descendant (including their widow, widower or surviving civil partner)

This also includes:

• a child who is, or was at any time, their stepchild
• their adopted child
• a child fostered at any time by them
• a child where they’re appointed as a guardian or special guardian when the child is under 18

The person who inherits the home does not have to be under the age of 18. A person’s stepchild is only someone whose parent is, or was, the spouse or civil partner of that person. Direct descendants do not include nephews, nieces, siblings, and other relatives who are not listed above. One or more direct descendants of the person that’s died can inherit a home, or a share of it. For a home left to people who are a mixture of direct descendants, other relatives or other people, you must share the value of the house in proportion to the share of the property each direct descendant inherits.

How do the direct descendants inherit the home?

For homes that qualify for the residence nil-rate band, specific rules govern how direct descendants inherit the home. The home must be left to them:

• in the will of the person that’s died
• under the rules of intestacy
• by some other legal means

The home does not have to be specifically mentioned in the person’s will. It can be inherited as part of what’s left of the estate (the residue) after considering specific legacies. The residue of the estate is what’s left after payment of:

• debts such as mortgages and loans
• funeral expenses
• executor’s fees
• taxes
• other expenses from administering the estate
• any specific gifts or legacies in the will

When a home forms part of the residue and has been passed on to multiple individuals, HMRC considers each person to have inherited a portion of the home. For the residence nil rate band, inheriting the home only counts if the direct descendants become entitled to the home upon the person's death. If the home is held in a trust before a person dies and remains in trust after their death, it will only qualify for the residence nil rate band if it becomes part of the direct descendant’s estate after the person dies. An estate will still be eligible for the residence nil rate band even if the direct descendants decide to sell the home after inheriting it.

How the residence nil rate band tapers for estates over £2 million

The residence nil rate band will gradually reduce, or taper away, for an estate worth more than £20 million, even if a home is left to direct descendants. It will reduce by £1 for every £2 that the estate is worth more than the £2 million taper threshold.

Taxation is a complex and evolving subject that requires careful consideration. The information presented here is intended solely for informational purposes and should not be construed as professional advice or relied upon as such. 

We encourage consultations with your tax advisor, accountant or financial advisor.