If you are married or in a civil partnership, then it is possible to reduce Inheritance Tax by utilising spouse exemptions and making the most of any transferable allowances. Unfortunately, the same exemptions and reliefs are not available to unmarried couples, regardless of how long they have been living together and the only way for them to benefit in the same way is to get married or to enter into a civil partnership.
In this blog, we consider how joint planning can benefit you from an Inheritance Tax (IHT) perspective.
1. Making Use of Both Nil Rate Bands
Every individual is entitled to a tax exempt amount on death. This is referred to as the Standard Nil Rate Band and is effectively the threshold above which Inheritance Tax is payable. The Nil Rate Band has been set at £325,000 since 2009 and this amount has been fixed until April 2026. This is the amount that you can pass on when you die before your estate is subject to Inheritance Tax.
However, any transfers between spouses are exempt. This means that you can pass on the full value of your estate to your spouse without any Inheritance Tax being payable. Of course, Inheritance Tax could still be payable upon second death (i.e. when both you and your spouse die). There are some exceptions to this, for example if your spouse has remarried or reduced the value of the estate by spending or gifting.
Because on first death, the Nil Rate Band was effectively not used due to the spouse exemption then on second death, the surviving spouse effectively has two nil rate bands to set against their estate. This is what is known as the Transferable Nil Rate Band. This means that as a couple (married or in a civil partnership), you can pass on up to £650,000 free of Inheritance Tax. Please note that this amount would be reduced if assets passed to anyone else other that your spouse or civil partner (or another exempt beneficiary such as a charity) on first death. Careful planning is required in the case of second marriages, to ensure the available nil rate bands are not lost.
As we have seen, the nil rate band has remained static now for over ten years and has been frozen until April 2026, while asset values and house prices continue to rise. This means that if the surviving spouse dies many years later, the nil rate band might not go as far towards eliminating the estate’s IHT liability.
2. Owning Property Jointly
The Residence Nil Rate Band (RNRB) was introduced to provide additional relief from Inheritance Tax against the value of the family home. This extends the nil rate band by up to £175,000 per individual, however, there are a number of caveats to this, but the main conditions are:
The relief cannot exceed the value of the property.
The property must be passed to what is deemed a lineal descendant, for example a child (including step-children) or grandchild.
The relief is gradually revoked on estates valued at over £2 million.
Passing on a jointly owned property on second death effectively doubles up on the RNRB, as couples can claim relief of up to £350,000 against the value of their home. This in effect means that couples who are married or in a civil partnership can have up to £1 million before Inheritance Tax becomes payable.
Unfortunately, as it stands, this main residence allowance isn't applicable to family members that aren’t direct descendants. When the new allowance came into force in April of 2017 it will initially extended a £100,000 allowance to every UK resident who left their main residence to one of their children (including adopted, foster or step children), their grandchildren or to their children in joint names with their respective spouses.
This means that by the 2021 tax year, when the main residence allowance is now £175,000, the average childless couple will be £350,000 worse off than couples with just a single child when it comes to Inheritance Tax. As is the case for the Standard Nil Rate Band, any unused main residence allowance can also be passed between spouses, although this will also be redundant for childless couples. And so, for the time being, those who don’t have direct descendants to whom they can leave their main residence will be unable to make use of this allowance.
Although the inequity of this suggests that we might see the law amended at some point in the future, for now those unable to make use of the new nil-rate band will find themselves facing larger potential inheritance tax bills than couples with children and will need to act accordingly.
3. Ensuring Death Benefits are Paid into Trust
When you die, your pension, death in service benefits, or life insurance can be paid out to your chosen beneficiaries rather than to your estate. In the case of pensions, and some company death in service schemes, no Inheritance Tax will apply when the benefits are paid out. However, please note that if your spouse receives a lump sum, this could substantially increase the value of their estate, and therefore their Inheritance Tax liability
Nominating assets during your lifetime and having these written into Trust can help to reduce the tax. Inheritance Tax wouldn't apply at the time of the payout, and the surviving spouse can still access the money providing they are named as a beneficiary, rather than receiving a lump sum which would then increase the value of their estate.
4. Regular Gifts
Every individual can benefit from an annual gift allowance of £3,000, which is known as the annual exemption. You can therefore give away assets or cash up to a total of £3,000 in a year without incurring Inheritance Tax. If you have not used the whole of the allowance in one tax year it can be carried forward to the next, up to a maximum of £6,000 but you are not allowed to accumulate several years’ worth of allowances and use it in a single large gift. If you do then it might be liable to Inheritance Tax. Generally making a gift worth more than the £3,000 allowance could potentially be subject to Inheritance Tax.
Your spouse has the same allowance, which means that you could jointly gift up to £12,000 in the first year, followed by £6,000 per year thereafter. Over time, this can create significant IHT savings.
As well as the annual gift allowance, you can give as many gifts of up to £250 to as many people as you want. You can also give wedding (or civil partnership) gifts which can be effective for Inheritance Tax purposes. It would not qualify if made after the wedding or if the wedding did not happen.
The amount of gift available would depend on your relationship to them.
To a child - £5,000 or less
To a grandchild or great-grandchild - £2,500 or less
or to another relative or friend - £1,000 or less
If you have enough income to maintain your usual standard of living, then you can make regular gifts from your surplus taxed income and this would be exempt from Inheritance Tax. To make use of this exemption, it’s very important that you can maintain good records of all your income and expenditure otherwise, when your executors wish to make a claim after you die, your beneficiaries could be faced with an Inheritance Tax bill.
You can gift as much as you like and as often as you like to a charity and this would be outside your estate for Inheritance Tax. In addition, if you left at least 10% or more of the ‘net value’ of your estate to a charity, then it reduces the rate of Inheritance Tax on some assets from 40% to 36%. This is often referred to at 10% for 10%.
5. Giving Away Lump Sums
The nil rate band is not only applicable upon death but it also relevant when making lifetime gifts. If you give away a lump sum, the amount (over and above any allowances) remains in your estate for 7 years. So if you give away £325,000 and die 5 years later, you have effectively used up your nil rate band. This is known as a Potentially Exempt Transfer ('PET') and if you survived 7 years then the value of this gift no longer forms part of your estate for the purposes of Inheritance Tax.
If you gift money into certain types of Trusts, Inheritance Tax may be payable immediately. If the gift is over £325,000, the tax charge is 20% on the excess. A further 20% would be payable if you died within 7 years. Additionally, periodic charges apply every ten years if the trust’s value exceeds £325,000. A couple could set up an appropriate trust arrangement to benefit in full from both nil rate bands.
Mitigating your exposure to Inheritance Tax is an essential part of your overall Estate Planning strategy and professional advice should be sought to help you achieve the best outcome otherwise your loved ones could find themselves having to pay a large Inheritance Tax bill before being able to inherit.