On top of the Nil Rate band of £325,000, since 2017, individuals can also receive the Residence Nil Rate Band. This is an allowance of £175,000, also taxed at 0% and available to those who own or have owned a property which they resided in, provided that they leave that property or the proceeds of the sale of that property through their Wills or via intestacy to their direct lineal descendants (i.e. Children or Grandchildren).
Should you be married, in a civil partnership or widowed, both the Nil Rate Band and the Residence Nil Rate Band are able to be transferred to the surviving spouse upon first death. Provided the entire estate has been left to the surviving spouse, there will be no Inheritance Tax to pay on first death and the Nil Rate Band would not be used as spousal exemption will apply.
If you are able to utilise the Nil Rate Band, Transferable Nil Rate Band, Residence Nil Rate Band and Transferable Residence Nil Rate Band in full, you would pay no tax on the first £1,000,000 of your estate. However, the Residence Nil Rate Band is reduced by £1 for every £2 of value once an estate exceeds £2,000,000.
Losing the total £350,000 tax free allowance of the Residence Nil Rate Band and Transferable Residence Nil Rate Band could cost you as much as £140,000 in Inheritance Tax depending on the size of your estate.
One solution which can enable you to utilise the Residence Nil Rate Band and Transferable Nil Rate Band should your estate fall between £2,000,000 and £2,400,000 is to, instead of transferring the £325,000 Nil Rate Band to your spouse on death, transfer the Nil Rate Band into a Discretionary Trust.
James and Catherine – Case Study
Catherine died and left all her belongings to her husband, James. On James’ death, his total Estate was valued at £2,200,000. As Catherine left everything to James, James was able to claim the Nil Rate Band and Transferable Nil Rate Band totalling £650,000. James had a house that was valued at £300,000 which he left to his son. As his estate was over £2,000,000, his Residence Nil Rate Band and Transferable Residence Nil Rate Band had tapered to a maximum of £250,000. This meant that, on James’ death, a total of £900,000 would be free of Inheritance Tax and there would be an Inheritance Tax payment due of £520,000 on the remaining value of his Estate.
Alternatively, had Catherine’s Will created a Discretionary Trust, removing £325,000 of her estate to be held by a separate Will Trust, the value of James’ Estate would have decreased to £1,875,000. On James’ death, only one Nil Rate Band (£325,000) would have been able to be claimed as Catherine’s Nil Rate Band would have been utilised by the Trust. As James’ Estate had been reduced below £2,000,000, upon his death the full Residence Nil Rate Band and Transferable Residence Nil Rate Band would have been able to be claimed. Therefore, a total of £1,000,000 of Catherine and James’ combined estate would be taxed at 0%, leaving a total Inheritance Tax bill of £480,000 and a Tax saving £40,000.
Ann and Mark – Case Study
Mark died and left everything to his wife, Ann. When Ann died her total Estate was valued at £2,400,000. Ann had a house valued at £500,000 which she left to her daughters. The full Nil Rate Band and Transferable Nil Rate Band were claimed, totalling £650,000. However, only £150,000 of the Residence Nil Rate Band was available to be used, as the remaining £200,000 had tapered away. This meant a total of £800,000 was able to be claimed at 0% tax, leaving a hefty Inheritance Tax bill of £640,000.
Had Mark’s Will created a Nil Rate Band Discretionary Trust, Ann’s estate would have been reduced to £2,175,000. This then would have allowed £262,500 of the Residence Nil Rate Band and Transferrable Residence Nil Rate Band to be claimed, as well as Ann’s Nil Rate Band of £325,000. Therefore, on Ann’s death, the combined tax free allowance for Mark and Ann’s joint estate would have been £912,500, leaving a total Inheritance Tax payable of £595,000 and a Tax saving £45,000.
Managing the Trust
The amount held by the Nil Rate Band Discretionary Trust would still be accessible to the surviving spouse. It would be invested accordingly, and the income could be paid to the surviving spouse or another named beneficiary.
This Trust essentially removes a full £325,000 from the estate, utilising the Nil Rate Band so that the transfer would be free of Inheritance Tax. The purpose of this is to place the Estate within range to claim most, if not all, of the Residence Nil Rate Band and Transferable Residence Nil Rate Band, depending on the size of your Estate.
By placing £325,000 in a Nil Rate Band Discretionary Trust, all of the growth on the property and investments from the date of the creation of the trust would be outside of the survivor’s Estate for Inheritance Tax purposes, and therefore decreasing the Inheritance Tax exposure on those assets.
The Trust would need to be administered and could be subject to 10-year anniversary charges or tax depending on the type of assets held by the Trust.
Further considerations
This approach is not the most tax efficient should your estate exceed £2,450,000 as removing the Nil Rate Band amount from your estate does not sufficiently reduce your estate to claim enough of the Residence Nil Rate Band and Transferable Residence Nil Rate Band to make tax savings.
It is important to continually review the value of your estate to ensure that your Will reflects your wishes and is drafted in the most tax effective way possible. Using a Trust is one of many tools that can be considered to reduce potential Inheritance Tax exposure for the future in certain circumstances. Please contact our Private Wealth team should you wish to discuss Estate Planning with one of our experts and start considering tax savings for the future.
