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Death estate
Inheritance tax is also payable on an individual’s estate on death. The rate is 40%.
An individual’s estate is basically the aggregate of all assets which they own less any liabilities (e.g., on a mortgage).
The NRB is available to offset against the death estate but may be reduced if, within seven years before death, the deceased made lifetime gifts.
Example 2: IHT on death
Paul died in the tax year 2024/25 with an estate worth £550,000. Two years before his death, he had gifted a cash sum of £25,000 to his son, Talbot.
The £25,000 is a PET and became chargeable due to Paul’s death within seven years of making it. However, as it fell within Paul’s NRB of £325,000, the rate of inheritance tax charged was 0%. Nevertheless, £25,000 of Paul’s NRB was used, leaving £300,000 of the NRB to offset against his death estate.
Inheritance tax on Paul’s estate was therefore 40% of [£550,000 – £300,000], giving a charge of £100,000.
In addition, in the case of death estates, there is also an additional allowance available referred to as the RNRB, i.e., the residence nil-rate band. The RNRB applies to deaths on or after 6 April 2017 and is currently worth a maximum amount of £175,000. Unlike the NRB discussed above, which is available to all individuals, this is not the case with respect to the RNRB.
To be entitled to the RNRB requires an individual to own a residence (basically, a home) which, on death, is left to the individual’s lineal descendants (i.e., children, grandchildren, great-grandchildren, etc.). If, in Mr Smith’s case, on his death, he left his residence to, say, his brother, he would not on his death then be entitled to the £175,000 RNRB (his brother not qualifying as a lineal descendant of Mr Smith).
The RNRB is only available for offset against an individual’s estate on death (not against lifetime gifts), whereas the NRB (discussed above) can be offset against either.
Using Mr Smith’s facts above, assume his only lifetime gifts were those he made to James and Susan, and when he dies, his estate consisted only of his house in which he was living, worth £550,000. Assume he died within seven years of making each of the two lifetime gifts.
When he dies, the two lifetime gifts (PETs) become chargeable to inheritance tax but (as set out above) only at the 0% rate. However, the two lifetime gifts, aggregating £35,000, used up £35,000 of his £325,000 NRB leaving £290,000 of his NRB. This means that he can use the £290,000 to offset against his death estate of £550,000. In addition, he also can use the RNRB of £175,000 (assuming he left his house to, say, one or both of his children); the RNRB is set off against the estate before the NRB.
So, on Mr Smith’s death estate of £550,000, the inheritance tax charged is:
[£550,000 – £175,000] – £290,000 = £85,000
The rate of inheritance tax on an individual’s death estate is 40%.
Inheritance tax payable is thus [40% x £85,000], namely, £34,000.
The £34,000 inheritance tax liability is typically payable out of Mr Smith’s estate.
‘£1m exemption’ – So-called!
It may be recalled that the Conservative party a few years ago announced that, under their then proposals, inheritance tax would not be payable on estates below £1m. This, not surprisingly, was just a touch misleading. They arrived at this £1m figure by pointing out that each individual had an NRB of £325,000 and an RNRB of £175,000, making £500,000 which became £1m for a married couple. But, as stated above, the £175,000 is not available to all individuals (e.g., if there are no children in the family) and even where there are children, the home must be left to them (i.e., inherited by them).
Exemptions and reliefs
In addition to the NRB and RNRB, the legislation also provides further specific exemptions and reliefs (some apply only in lifetime; some apply only on death; and some apply in both cases). One exemption of particular relevance is the inter-spouse or civil partner exemption, i.e., gifts made between spouses or civil partners. Such gifts, whether in lifetime or on death, are simply exempt from IHT (unless the donor spouse or civil partner is a UK domiciled spouse and the donee spouse or civil partner is non-UK domiciled, in which case the exemption is restricted; or, post-5 April 2025, the donor spouse or civil partner is a long-term UK resident and the donee spouse or civil partner is not a long-term UK resident). In principle, this allows tax-free movement of assets between spouses. If, on the death of the first spouse to die, their estate is left completely to the surviving spouse, no IHT liability arises on the estate until the death of the surviving spouse. If there is a significant age differential, this could mean a significant deferral of any IHT charge (assuming the older spouse dies first).
Another exemption (often not fully utilised) is the annual exemption worth £3,000 each tax year; thus, a gift or gifts totalling up to £3,000 can be given each tax year without an inheritance tax charge whether the transferor or donor dies within the seven-year period or not. A married couple can each give £3,000 per tax year, i.e., a total of £6,000 each tax year.
A major relief (not an exemption) is business property relief (BPR), under which, depending upon the facts, a business may be gifted without an inheritance tax charge as 100% relief may apply. A not dissimilar relief is agricultural property relief (APR).
Anti-avoidance: Reservation of benefit
Not surprisingly, the legislation also contains provisions designed to prevent certain types of IHT planning. Two major such provisions are the ‘reservation of benefit’ provisions and the ‘pre-owned asset’ provisions.
The former provisions are designed to stop an individual giving away an asset but continuing to enjoy it thereafter. The classic example concerns an individual’s house. In the above example Mr Smith lives in his house. To avoid IHT arising on the house when he dies (the house will form part of his death estate), he makes a lifetime gift of it to his daughter, Susan (a PET). However, he continues to live in it as he always has, even though it is then owned by Susan. Unfortunately for Mr Smith, he is, as a result, treated as if he has ‘reserved a benefit’ in the house (as he continues to live in it or enjoy it) and so on his death, the house is treated as still forming part of his estate and IHT is accordingly charged on it (even though, in law, Susan owns the house) (see chapter 5).
Trusts
Although the above has concentrated on gifts by individuals to other individuals, the IHT legislation also applies with respect to trusts. For IHT purposes, there are, in principle, two categories of trust, namely, relevant property trusts and qualifying interest in possession trusts. Relevant property trusts comprise trusts with no qualifying interest in possession beneficiaries and trusts in which a non-qualifying interest in possession subsists.
In the case of a relevant property trust, the trust is itself treated as a separate entity and IHT is charged on the property held in the trust by the trustees. This is not the position with respect to qualifying interest in possession trusts, where the IHT charge arises on the qualifying interest in possession beneficiaries.
Relevant property trusts (broadly, discretionary trusts) are widely used in tax planning.
Planning
The essence of inheritance tax planning is to look at an individual’s overall family circumstances as they subsist both in lifetime and on death. Sometimes, the existence of an exemption or relief may point to an advantage being had by making one or more lifetime gifts, whilst at other times, gifting on death (by will) may be more tax-efficient.
