What is Inheritance Tax?
Inheritance tax (‘IHT’) is a capital tax on an individual’s estate when they die. An individual’s estate comprises of all property, possessions and money owned at the date of their death.
The current rate of IHT is 40% and is payable on estates that are valued at over £325,000. Other IHT reliefs are available to reduce an individual’s taxable estate and these will be covered in subsequent articles.
For married couples and members of civil partnerships, IHT is normally only a consideration on the death of the second spouse/civil partner as transfers of assets on death to a spouse/civil partner is exempt from IHT.
What is the Nil Rate Band?
The Nil Rate Band (‘NRB’) is simply a band within which no IHT is chargeable. The current NRB is £325,000 per individual. The NRB is automatically available to all individuals with assets that would be subject to IHT in the UK.
When calculating IHT payable on death the NRB is reduced by any transfers made by an individual in the 7 years before their death to:
- relevant property trusts (known as a chargeable lifetime transfer or ‘CLT’); and/or
- gifts/transfers to individuals and/or certain types of trusts (known as a potentially exempt transfers or ‘PET’).
It is also necessary to look at CLTs made in the seven years before a PET to see whether the failed PET was covered by the nil rate band at the time it was made. Hence, it may be necessary to consider a transfer window of up to 14 years prior to a PET being made (see Ted example below).
Example: In July 2012 Ted made a chargeable transfer to a Trust of £200,000. In July 2018 Ted gave £150,000 to his daughter. The £150,000 gift is a PET. Ted died in August 2020 and the PET in July 2018 now becomes a chargeable transfer.
Had no chargeable transfer been made in July 2012, the PET made in July 2018 would have been fully covered by Ted’s NRB of £325,000 and no IHT would have been payable on the PET following his death. However, since it is necessary to consider CLT’s made in the 7 years leading up to the date of the PET, the NRB is reduced by the value of the CLT made in July 2012 (i.e. by £200,000) meaning that only £125,000 of the NRB remains to be used against the value of the PET. Therefore, Ted’s estate is subject to IHT on £25,000 of the PET (i.e. £150,000 less NRB remaining of £125,000).
Therefore, individuals wishing to pass wealth to the next generation should begin this process as early as possible with the aim of preserving as much of their NRB as possible to be used against their death estate.
Can I transfer some or all of my NRB?
Under normal circumstances it is not possible to transfer the NRB to another person – whether used or not. However, for married couples and members of a civil partnership, it is possible for the unused proportion of the NRB of the first spouse or civil partner to be transferred to the surviving spouse. This means that any part of the NRB that is not used on the death of the first spouse or civil partner can be transferred to the surviving spouse or civil partner for use on the later death. Thus the surviving spouse/civil partner can potentially avail of two full NRB’s (i.e. £650k) assuming all assets transfer to the surviving spouse/civil partner on death. It is necessary to make a claim for any unused NRB to be transferred to the surviving spouse and it is therefore imperative that this valuable relief is not overlooked.
Key takeaways
- IHT is payable at 40% where an individual’s estate exceeds £325,000
- IHT is typically payable on death of surviving spouse/civil partner (where all assets transfer to the surviving spouse/civil partner on first death)
- Ensure any lifetime gifts are made sooner rather than later
- Don’t forget that married couples and members of civil partnerships can transfer unused NRB to their surviving spouse/civil partner.
To discuss your own situation or to find out more contact: Chris Bradley, Tax Manager E: chrisbradley@bakertillymm.co.uk or Angela Keery, Tax Director E: angelakeery@bakertillymm.co.uk or T: 028 9032 3466