Inheritance tax has a reputation out of all proportion to how often it is actually paid: fewer than one estate in twenty ends up with a bill. The reason is the nil rate band, the slice of an estate that passes tax free before anything is charged at all. Work out how the nil rate band applies to you, and how a second band attached to your home stacks on top of it, and you will know within ten minutes whether inheritance tax is your problem or somebody else’s.
What is the nil rate band?
The nil rate band is the amount you can leave before inheritance tax bites. It has stood at £325,000 since 2009, and it has been frozen rather than raised for so long that it is now expected to stay put for the rest of the decade. Everything above it is taxed at 40 per cent. The band applies to the whole estate: the house, savings, investments, the car, the contents of the loft, and your share of anything owned jointly. Debts and funeral costs come off first.
The arithmetic is unforgiving but simple. An estate of £400,000 with no other reliefs pays 40 per cent on the £75,000 above the band, a bill of £30,000. An estate of £300,000 pays nothing. Frozen thresholds are why more ordinary estates cross the line every year: house prices moved and the band did not, which is how a terraced house in the wrong postcode became an inheritance tax problem.
The residence nil rate band: another £175,000, with strings
Since April 2020 a second band has sat on top of the first. The residence nil rate band is worth up to £175,000 and exists to lift the family home out of the tax net. It comes with conditions, and every one of them catches somebody out:
- It applies to a home you actually lived in. A buy-to-let you never occupied does not qualify.
- The home, or a share of it, must pass to direct descendants: children, grandchildren and great-grandchildren, including step, adopted and foster children. Nieces, nephews, siblings and friends do not count, however close you were.
- It is capped by the value of the property. A flat worth £120,000 gives £120,000 of band, not £175,000.
- If you downsized or sold up after 8 July 2015, a downsizing addition can preserve the band you would have had, provided the replacement assets still reach direct descendants.
- Leave the house into the wrong kind of trust and the band can disappear. A discretionary trust for your children is not the same thing as a gift to your children, and that distinction is worth £70,000 of tax: property trusts in wills sets out where the line falls.
Why do couples talk about a £1 million threshold?
Anything you leave to a husband, wife or civil partner is exempt from inheritance tax outright, and their allowances are not wasted either. Whatever proportion of the nil rate band goes unused on the first death transfers to the survivor, and the same is true of the residence band. Two full bands plus two residence bands is £325,000 and £325,000 and £175,000 and £175,000, which is where the famous million comes from.
Two caveats sit under that headline. It is a couple’s ceiling, not an individual’s: a single person with no children tops out at £325,000, and unmarried partners get no transfer whatsoever, which is one of several reasons cohabiting couples need a will more than married ones do. And the transfer is claimed, not granted. The survivor’s executors have to make the claim, supported by the first spouse’s will, death certificate and grant of probate. Those papers may be needed thirty years later, so keep them somewhere findable rather than somewhere safe.
The £2 million line that quietly removes the extra band
The residence nil rate band tapers away on larger estates, losing £1 of band for every £2 of value above £2 million. At roughly £2.35 million a single estate has lost the whole £175,000, and a widow or widower carrying a transferred band loses both by around £2.7 million. The £2 million test is applied before certain reliefs and exemptions come off, so an estate holding a business or a farm can be over the line even when the eventual taxable figure looks far smaller. That is the point where a will stops being a form and becomes a plan.
What the bands do not cover
- Gifts made in the seven years before death. They are set against the nil rate band first, before the estate gets to use it, so a generous gift can quietly consume the band your will was counting on.
- Property owned as joint tenants. It passes to the survivor automatically, outside the will entirely, and still counts in the estate for tax.
- Pensions. Most pots have historically sat outside the estate for inheritance tax, and that treatment is due to change from April 2027. If a pension is a large part of what you will leave, check the position as it stands before relying on older advice.
- Assets already held in trust, which have their own inheritance tax regime and their own reporting.
What actually reduces a bill
Four things do real work here, and only one of them is remotely clever. Before any of them, get your bearings: our free inheritance tax calculator runs the current allowances, the taper and the charity rate against your own figures in under a minute.
- The spouse exemption. It defers the tax to the second death rather than removing it, and it keeps both sets of bands alive in the meantime.
- Charity. Gifts to charity are exempt, and leaving at least 10 per cent of the net estate cuts the rate on everything else from 40 to 36 per cent. Leaving money to charity in your will works through the arithmetic, which is stranger and more generous than most people expect.
- Lifetime giving, inside the seven-year rule and the annual exemptions. Regular gifts genuinely made out of surplus income carry their own exemption and are badly underused.
- Drafting that matches the reliefs: the home reaching direct descendants in a qualifying way, business and agricultural property held in a form that still attracts relief (the rules here were tightened recently, so check rather than assume), and a residue clause that divides what is left in the shares you actually intended, because the residue is where most of the tax lands.
Where the will does the work
For most estates the honest answer is that inheritance tax is a non-issue, and the job is a valid, unambiguous will rather than a tax structure. Willful’s guided interview asks about property, business interests, trusts and charitable gifts as a matter of course, and an SRA-regulated solicitor reviews every will before you sign. Where the answers point at an estate crossing the bands, the complex tier is where trusts and structured gifts get drafted properly. Past a million pounds or so, particularly with a business or a farm in the mix, a specialist adviser working alongside the will is money well spent, and we would rather say that than pretend a questionnaire replaces one.