Many people know that Inheritance Tax is normally charged at 40%.
Far fewer realise that once an estate exceeds £2 million, another valuable Inheritance Tax allowance starts to disappear.
This can mean that, for some estates, reducing the value by £1 can potentially save 60p in Inheritance Tax.
What is the Residence Nil Rate Band?
Most people have a standard Inheritance Tax Nil Rate Band of £325,000.
There is also an additional allowance known as the Residence Nil Rate Band (RNRB), currently worth up to £175,000, where a qualifying home passes to children or other direct descendants.
For a married couple or civil partners, unused allowances can potentially transfer to the surviving spouse or civil partner.
This means that, in the right circumstances, a surviving spouse could potentially have:
- £650,000 of standard Nil Rate Band
- £350,000 of Residence Nil Rate Band
giving total potential allowances of £1 million.
However, there is an important catch.
What happens when the estate is worth more than £2 million?
Once the estate exceeds £2 million, the Residence Nil Rate Band starts to be withdrawn.
For every £2 that the estate exceeds £2 million, £1 of Residence Nil Rate Band is lost.
So it is not a case of suddenly losing the whole allowance at £2,000,001.
Instead, it gradually reduces as the estate becomes larger.
For an individual with one £175,000 Residence Nil Rate Band, it is completely lost once the estate reaches £2.35 million.
Where a surviving spouse has the full transferred allowance of £350,000, it is completely lost once the estate reaches £2.7 million.
What difference can this make?
Let’s look at an example of a surviving spouse who potentially has:
- £650,000 standard Nil Rate Band
- £350,000 Residence Nil Rate Band
- a qualifying residence passing to direct descendants
The figures below show just how significant the £2 million taper can be.
| Estate value | RNRB remaining | Approximate IHT | Reduction in IHT |
| £2,700,000 | £0 | £820,000 | |
| £2,500,000 | £100,000 | £700,000 | £120,000 |
| £2,250,000 | £225,000 | £550,000 | £150,000 |
| £2,100,000 | £300,000 | £460,000 | £90,000 |
| £2,000,000 | £350,000 | £400,000 | £60,000 |
These figures are simplified examples and assume that the full transferred allowances are available.
But look in particular at the difference between an estate worth £2.5 million and one worth £2.25 million.
The estate has reduced by £250,000.
Yet the estimated Inheritance Tax has reduced by £150,000.
Why does a £250,000 reduction save £150,000 of tax?
Normally, removing £250,000 from an estate that would otherwise be taxed at 40% could reduce IHT by:
£250,000 × 40% = £100,000
But there is a second benefit.
Reducing the estate from £2.5 million to £2.25 million also restores £125,000 of Residence Nil Rate Band.
That additional allowance is worth:
£125,000 × 40% = £50,000
So the potential total reduction in IHT is:
£100,000 + £50,000 = £150,000
This means that while an estate is within the Residence Nil Rate Band taper range, the effective marginal IHT saving from reducing the estate can be 60%.
For every £1 by which the estate is reduced:
- 40p may be saved because that £1 is no longer subject to IHT
- a further 20p may be saved because 50p of Residence Nil Rate Band is restored
Total potential saving: 60p.
Does this mean you should simply give money away?
No.
Inheritance Tax planning should never be looked at in isolation.
Someone may have an estate worth more than £2 million but still need their investments and savings to provide income or security for the rest of their life.
There are also separate rules covering lifetime gifts, including the seven-year rule, and different tax consequences may arise depending on which assets are given away.
The Residence Nil Rate Band itself does not apply to lifetime gifts, and gifts made within seven years of death can affect the amount of the standard Nil Rate Band available against the estate.
Investment decisions also need particular care. Some investments may qualify for Business Relief for Inheritance Tax purposes, but their value can still be taken into account when looking at whether the estate exceeds the £2 million RNRB taper threshold. The £2 million test broadly looks at the net estate after liabilities but before IHT reliefs and exemptions.
The important point: know where you stand
The £2 million threshold is therefore an important figure for families to be aware of.
If an estate is around £2 million to £2.7 million, relatively modest changes in its value can sometimes have a surprisingly large effect on the eventual Inheritance Tax bill.
It doesn’t automatically mean that assets should be given away.
But it does mean that it is worth understanding:
- what the estate is currently worth
- which Inheritance Tax allowances are likely to be available
- which assets produce income that is still needed
- whether existing investments have been set up specifically for Inheritance Tax planning
- and whether any sensible planning opportunities should be discussed with your accountant, financial adviser or solicitor
Sometimes the first step in Inheritance Tax planning isn’t making any changes at all.
It is simply doing the calculation and understanding the numbers.
Could this affect your estate?
If your estate is worth around £2 million or more, it is worth checking how much of the Residence Nil Rate Band you are actually likely to receive.
A relatively small change in the value of an estate can sometimes make a surprisingly large difference to the eventual Inheritance Tax bill.
At DNA Accountants, we can help you understand how the numbers work, identify where the Residence Nil Rate Band taper may affect you and, where appropriate, work alongside your financial adviser or solicitor to consider the options available.
If you would like us to review your position, please get in touch.