Understanding the inheritance tax allowance or ‘nil rate band’

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You don’t have to pay inheritance tax on everything you leave; in fact in the current tax year (2016-2017) you can leave up to £325,000 worth of assets (such as property, savings, pensions etc) and there won’t be any inheritance tax (IHT) to pay. And even if you’re worth more, you may still escape IHT.

The basics of inheritance tax
First of all it’s not the person leaving behind the money or assets that has to pay inheritance tax. It’s a tax that’s paid after they’ve died, and it comes out of the proceeds of the estate that’s left behind and is normally paid by the executor (that’s the person who has to sort out your financial affairs after you’ve died).

SAVVY TIP: The ‘estate’ is just a term that describes all the property, money, possessions etc that you own, minus anything you owe.

– Anything you leave to your husband or civil partner doesn’t count for inheritance tax purposes. That means that if your share of the property you own and your savings comes to — for example – £500,000 and you left it all to your husband, he wouldn’t have to pay inheritance tax. However, if you left the same property and savings to your children they would have to pay inheritance tax.

SAVVY TIP: The same rules don’t apply to couples who live together but who aren’t married.

– Inheritance tax is payable at 40%. Unlike some taxes – such as income tax – which has tiered rates depending on how much you earn, there’s one flat rate of inheritance tax of 40% on anything above the inheritance tax allowance of £325,000 (in tax year 2016-2017).

Saving tax with the nil rate band
You can leave money and possessions worth up to £325,000 — called the nil rate band or inheritance tax allowance – to whoever you like, and there won’t be any inheritance tax to pay.

Using an example:
If you left £500,000 to your children, the first £325,000 (the inheritance tax allowance in 2016-17) would be free of tax. That would mean that your estate wouldn’t have to pay inheritance tax on the full £500,000 but on £175,000 (£500,000-£325,000 = £175,000). So the inheritance tax bill would be £70,000 (£175,000 x 40%= £70,000).

Unless you took other inheritance tax saving measures, anything you left to family members apart from your husband or civil partner would incur an inheritance tax bill. However, it’s a little more complicated than that as there is one other useful tax-saving measure which was introduced in 2007.

– If you’re married or in a civil partnership you can effectively double your inheritance tax allowance to £650,000. This concession was introduced in October 2007 and applied to couples where either the husband or the wife was still alive on October 9th 2007.

The easiest way to explain it is by using an example:

Supposing Mr Jones died in 2005 having left £100,000 of his possessions to his wife. In 2015, Mrs Jones dies. Mr. Jones would have used 36% of his inheritance tax allowance or ‘nil rate band’ when he died in 2005.

SAVVY TIP: The percentage relates to the nil rate band that applied at the time of death. In the tax year 2005-2006 it was £275,000. £100,000 is 36% of £275,000.

When Mrs. Jones dies there is around 64% of unused inheritance tax allowance available. In 2016 the inheritance tax allowance is £325,000, and 64% of that is £208,000. That means that Mrs. Jones can leave £533,000 (her own inheritance tax allowance of £325,000 + £208,000 from her late husband) to whoever she wants to without there being any inheritance tax to pay. You can check the inheritance tax thresholds on the Gov.uk website.

SAVVY TIP: There’s more information about how married couples can transfer the unused inheritance tax allowance or nil rate band in my article entitled transferring your inheritance tax allowance to your spouse or civil partner.

Related articles:

How can you reduce your inheritance tax bill?

Using inheritance tax allowances to cut your IHT bill.

Dying tidily. How to make life easier for those you leave behind

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