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You may have read our recent piece on the rise of Inheritance Tax (IHT) investigations in the UK, which have put 14,000 estates under the spotlight for potentially underpaying the tax.
In it, we issued a reminder of the frozen nil-rate band and residence nil-rate band – the thresholds under which an estate can be passed down IHT-free.
But there is one additional IHT trap we did not mention: the tapering of the residence nil-rate band for estates worth £2 million or more.
In combination with a key rule change regarding pensions and IHT, set to come into place in April 2027, the residence nil-rate band taper will make it more difficult for large estates to mitigate IHT.
The nil-rate bands have not increased in value for several years, and are frozen until 2031
The main nil-rate band used to rise in line with inflation.
In 2009, the government froze the nil-rate band at £325,000, where it has remained ever since. As mentioned, the nil-rate band will stay fixed at £325,000 until 2031.
In 2017, the government announced an additional tax break, the residence nil-rate band, which can be claimed if the person’s main residence is passed to a “direct descendant” – children, stepchildren, grandchildren, and so on. The residence nil-rate band was initially brought in at £100,000 and frozen at £175,000 in 2020; it is being kept at this level until 2031.
In combination, the nil-rate bands allow an individual leaving their main home to a child or grandchild to pass on up to £500,000 – including their home – without IHT being due. The remaining portion of the estate would be liable for IHT at a rate of 40%, not accounting for trusts or tax-free lifetime gifts.
Spouses and civil partners are exempt, so if you were to leave your estate (or a portion of it) to them, no IHT would be due. They can also claim your unused nil-rate bands.
Example:
John passes away and leaves his £1 million estate, including his home, to his husband, David.
When David dies a year later, his executor claims John’s unused nil-rate bands, meaning their daughter inherits £1 million IHT-free.
This is a very simplistic view that doesn’t account for trusts, gifting, or other reliefs, but it illustrates how the nil-rate bands function in basic terms.
For larger estates, though, the residence nil-rate band can be tapered away, exposing a bigger portion of the estate to IHT (more on this later).
Pensions will be included in Inheritance Tax investigations from April 2027
At the time of writing, unused pension benefits fall outside of your estate for IHT purposes.
Using the above example, John and David could both have passed down pensions of any value to their daughter without this triggering a further IHT charge.
In April 2027, this is set to change, and pensions will be included in IHT calculations.
Not only have the frozen nil-rate bands left your estate vulnerable to IHT, but the inclusion of pensions could significantly increase the value of your taxable estate and further subject your wealth to the tax when you die.
This change could even push your estate over the £2 million threshold which, in turn, could increase the amount of IHT your estate is subject to due to the tapering of the residence nil-rate band.
Estates worth £2 million or more could see their residence nil-rate band tapered down to zero
To increase the tax take from high-value estates, the government tapers the residence nil-rate band down from £175,000 to £0 if an estate is worth more than £2 million.
The taper functions as follows:
- Over £2 million, every £2 results in a £1 reduction in the residence nil-rate band.
- Once the estate reaches £2.35 million in value, or £2.7 million if claiming a spouse or civil partner’s unused residence nil-rate band, the allowance disappears completely.
The main nil-rate band remains in place for all estates.
For argument’s sake, if you left an estate worth £2.5 million to a non-spousal beneficiary, only £325,000 could be inherited tax-free. Once again, this does not account for trusts or other IHT-mitigating strategies.
Benefit from clear, unbiased Inheritance Tax guidance from your Wealth Planner
The reality is that while the value of your assets increases over time, more will be dragged over the frozen IHT thresholds.
Plus, the residence nil-rate band taper leaves even less room for bequeathing a tax-free inheritance to your children, grandchildren, and other loved ones.
Our Wealth Planners:
- Understand the IHT legislation front to back
- Have you and your family’s best interests at heart
- Operate on a bespoke basis, so no two individuals’ wealth plans will function in the same way.
It is never too early to form an intergenerational wealth plan that helps you leave more of what you hold dear in the hands of your family.
Contact your Relationship Manager to learn more – or if you do not already work with us, email info@ipscap.com for more information.
Please note
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
The Financial Conduct Authority does not regulate tax planning, trusts, will writing, tax planning, or estate planning.
IPS Capital does not provide tax or legal advice.
