In recent years, the government has chosen to freeze the inheritance tax (IHT) nil-rate band and related reliefs, a move with significant implications for individuals and families. Understanding how these freezes affect IHT liabilities is crucial for effective estate planning.
What is the Nil-Rate Band?
The main IHT exemption, the nil-rate band is the threshold up to which an estate is not subject to IHT. Currently, the nil-rate band stands at £325,000. Any part of an estate above this threshold is generally taxed at 40%. The nil-rate band is intended to increase in line with inflation, but the government can, and has, chosen to freeze it at a fixed amount since 2009.
What does freezing the Nil-Rate Band mean?
The nil rate band has not increased in line with inflation since 2009 and has now been frozen until 2030. As a result, as property values and other assets rise over time, more estates exceed the threshold and become liable to IHT or pay more tax than they would have if the band had increased.
Had the nil rate band kept pace with inflation, the nil rate band would rise to over £500,000 by 2029/30. This phenomenon is often referred to as “fiscal drag.”
Transferable Nil-Rate Band
If a person leaves their estate to their spouse or civil partner, any unused nil-rate band can be transferred to the survivor. However, the amount transferred is based on the nil-rate band at the time of the survivor’s death. If the nil-rate band remains frozen, the survivor’s estate cannot benefit from a higher threshold that would have resulted from indexation.
Residence Nil-Rate Band (RNRB)
In addition to the standard nil-rate band, there is a residence nil-rate band (RNRB), which applies when a home is left to direct descendants. The RNRB is currently set at £175,000 and, like the main nil-rate band, has not increased since it was introduced in 2017. This means the real value of the RNRB is eroded over time, and fewer estates benefit fully from this relief as property prices rise.
Practical Consequences
- More estates liable to IHT: As asset values increase but the nil-rate band remains static, more estates are pushed above the threshold and become liable to IHT.
- Small annual exemption: The £3,000 annual exemption and other small gift reliefs have remained unchanged since the 1980’s and no longer cover the majority of small gifts made today.
- Higher tax bills: Estates already above the threshold may face higher tax bills as the real value of the nil-rate band and RNRB declines.
- Estate planning complexity: The interaction of the frozen nil-rate band, transferable nil-rate band, and RNRB increases the complexity of IHT calculations and planning. Regular reviews of wills and estate plans are essential to ensure all available reliefs and exemptions are used effectively.
Conclusion
The freezing of the nil-rate band and related reliefs for inheritance tax means that thresholds do not keep pace with inflation, resulting in more estates being subject to IHT and bumper receipts for the Exchequer. The real value of these reliefs erodes over time, making careful estate planning and the use of available reliefs more important than ever.
If you are concerned about how these changes may affect your estate, we recommend seeking professional advice to ensure your affairs are structured as efficiently as possible. Contact Kay Aylott at Kaylott@haysmac.com to discuss your needs.
