Inheritance tax (IHT) planning can be complex, but a clear understanding of the various nil-rate bands is a good first step in demystifying this area of taxation. 

This article provides an in-depth look at how you can leverage the standard nil-rate band, the spousal unused nil-rate band, and the additional nil-rate band for the family home to optimise your estate planning. Note that this only applies to individuals domiciled in the UK; the specific rules for non-UK domiciled individuals may differ.

The four nil-rate bands on death

1. Standard nil-rate band

Upon the death of an individual, the first £325,000 of their estate is taxed at 0% for IHT purposes. This is known as the standard nil-rate band and applies to all estates. Specific details of this provision can be found under s7 Sch 1 of the Inheritance Tax Act 1984.

2. Spousal unused nil-rate band

When one spouse or civil partner passes away, the surviving spouse can inherit any unused portion of the deceased's nil-rate band. This inherited percentage is then applied to the nil-rate band available at the time of the surviving spouse’s death. Note that where the nil rate band has changed between the first and second deaths, the relevant nil-rate band is that at the second death. Specific details of this provision can be found under s8A-s8C IHTA 1984.

Scenario:

Daisy passed away in January 2008, leaving her entire estate to her husband, Paul, thus not using any of her nil-rate band of £300,000. When Paul dies in 2023, the nil-rate band has increased to £325,000. Paul's estate can now benefit from Daisy's unused nil-rate band, effectively doubling the tax-free threshold to £650,000.

3. Additional nil-rate band for main residence

An additional nil-rate band is available when a deceased individual leaves a main residence to direct descendants, such as children or grandchildren. This additional band was phased in from the tax year ended 5 April 2017 and reached £175,000 in the tax year ended 5 April 2021. This band can also be transferred to a surviving spouse. Specific details of this provision can be found under IHTA 1984 ss8D-8M.

The residential nil rate band is withdrawn for estates with a value of over £2 million at a rate of £1 for every £2 the estate value exceeds the £2 million threshold, and is fully withdrawn for estates with a total value of over £2.25 million.

Scenario:

Harry passed away in 2015 and left his estate to his wife, Taylor, including their family home. Harry did not use his residence nil-rate band. Taylor passes away in 2024, leaving her entire estate, including the family home, to their children. The total residence nil-rate band available to Taylor's estate is £350,000 (her own £175,000 plus Harry's £175,000).

4. Combined nil-rate bands

‍For a married couple, the combined nil-rate bands, where a family home is passed to direct descendants, can amount to £1 million, taking into account the standard nil-rate bands and the residence nil-rate bands (£325,000 + £325,000 + £175,000 + £175,000).

Extending the benefits: Up to £1.5 million tax-free

‍With careful planning, it is possible in certain circumstances for individuals who embark on new relationships following the death of their previous spouse to benefit from any unused nil-rate bands from these previous marriages, and thus potentially extending the total available nil-rate bands to up to £1.5 million. Note that this would require some fairly narrow circumstances to be able to benefit from multiple additional nil rate bands, and it is imperative for wills to be drafted correctly to be able to benefit.  

Scenario:

Consider Sam and Chloe, both of whom inherited unused nil-rate bands from their late spouses. Sam's first wife, Sophia, did not use her £325,000 nil-rate band, and similarly, Chloe's first husband, Marcus, left his entire estate to her, not utilising his nil-rate band. When Sam and Chloe pass away, their estates can benefit from these inherited nil-rate bands, in addition to their own.

Sam's estate: Standard nil-rate band (£325,000) + Sophia's unused nil-rate band (£325,000) 

Chloe's estate: Standard nil-rate band (£325,000) + Marcus' unused nil-rate band (£325,000)

By effectively utilising these provisions, Sam and Chloe's combined estates can potentially benefit from up to £1.3 million being taxed at the nil rate.

Key considerations
As noted above, the residential nil-rate band is subject to tapering for estates exceeding £2 million, reducing by £1 for every £2 over this threshold. Thus, larger estates may not fully benefit from this relief. The 'regular' nil-rate band is not subject to tapering for larger estates.

Conclusion
Effectively utilising these nil-rate bands can significantly reduce the IHT burden on your estate. Timely claims and strategic planning can ensure that – for the majority of individuals – up to £1 million of their estate is taxed at the nil rate, preserving more wealth for future generations. 

At Sanctoras, we specialise in guiding clients through the intricacies of IHT planning to maximise these benefits. For personalised advice on inheritance tax planning and optimising your estate, please contact Ed Maycock at em@sanctoras.com